Commentary:
The Nasdaq Composite kicked off the holiday-shortened week with a higher volume session of gains that pushed the index to a new six-year high. The first forty-five minutes of trading were looking pretty bleak, as the Nasdaq had fallen below support of its short-term consolidation and was showing a 0.7% loss. But the bulls reversed the situation, promptly erasing the loss and eventually sending the Nasdaq to a 0.7% closing gain. The S&P Midcap 400 also gained 0.7%, but less enthusiasm was found in the S&P 500 and Dow Jones Industrial Average, which closed higher by 0.3% and 0.2% respectively. The small-cap Russell 2000 turned in the best performance with a 1.0% advance.
Turnover in the NYSE declined by 3% yesterday, but total volume in the Nasdaq surged 15% above the previous day’s level. The solid gain on firmly higher volume enabled the Nasdaq to register its second “accumulation day” within the past five sessions. Strong market internals also confirmed the institutional buying. Advancing volume in the Nasdaq exceeded declining volume by a margin of 3.5 to 1. The NYSE ratio was positive by only 3 to 2.
Yesterday, all but one of the major indices closed at a new high. The S&P 500 and Nasdaq Composite both finished at six-year highs, while the Dow, S&P Midcap, and Russell 2000 indices all finished at record highs. Only the tech-concentrated Nasdaq-100 Index remains in a range. Because most of the indices were already trading at their highs, the new highs they set yesterday were not very surprising. Even the Dow’s modest 0.2% gain, for example, was enough to send the index to another all-time high. It was significant, however, that the Nasdaq Composite finally cleared resistance just over the 2,500 level. Last week, the Nasdaq was in the process of completing the right shoulder of a bearish “head and shoulders” chart pattern, but the rally over the top of the “head” (the high of January 16) has invalidated the pattern:
With the S&P, Nasdaq, and Dow all trading at new highs, there is literally a complete lack of overhead supply and price resistance. Stocks and indexes trading at 52-week highs can move higher with minimal buying pressure because there is simply an absence of investors and traders who are selling into strength “just to break even.” Remember that supply and demand, pure and simple, moves the markets. Nevertheless, astute traders must continually assess the overall risk/reward of entering new positions.
In case you are not familiar with the term, “risk/reward” is a measure of the amount of risk a trade setup incurs, compared the potential profit (reward) if the trade goes as planned. For every trade we enter, we require a risk/reward of at least 1 to 2. If, for example, we are buying an ETF that requires a protective stop 2 points away from the current price, the realistic price target must be at least 4 points away from the current price. It it is, then our risk/reward ratio on the trade setup would be 1 to 2. Trade setups with a ratio of 1 to 3 or better are prized. The higher the risk/reward ratio, the more times you can stop out of a trade and still be net profitable at the end of the month. Conversely, taking setups with a low risk/reward ratio of 1 to 1 requires a much higher rate of accuracy.
With no overhead resistance levels to speak of, the short-term odds obviously favor the long side of the S&P, Nasdaq, and Dow. However, we must be cognizant of the actual risk/reward of the broad market at current levels. With the S&P and Dow both trading well above the upper channel of their long-term uptrends and the indices working on nine consecutive months of gains, we can’t help but wonder how much more upside remains (reward) compared the amount of downside (risk) when the inevitable correction sets in.
Looking at the weekly charts, a correction in the S&P 500 just down to the upper channel of its long-term uptrend would put the index around the 1,400 level. A 50% Fibonacci retracement from its July 2006 low up to its current high would put the S&P around the 1,342 level:
A sell-off down to the 1,400 level would represent a 4% drop from its current price, while a 50% Fibonacci retracement would be an 8% drop. What is the likelihood of the S&P rallying 8% to 16% more without a correction? Unless you trade only short-term momentum and are nimble/willing enough to close positions immediately after entering them, it seems we are clearly facing a negative risk/reward ratio on all new long entries. Unfortunately, the situation in the Dow is very similar, but the Nasdaq could be the saving grace. Since it just broke out to a new high after three months of sideways consolidation, the overall risk/reward in the Nasdaq is better.
If you’re one of the aforementioned short-term momentum traders, go ahead and keep playing the odds on the long side of the market. Otherwise, please tread very lightly at current levels, keeping a healthy percentage of cash in your portfolio. Yesterday, we listed four different sector ETFs we were watching for potential entry. We bought the PowerShares Clean Energy (PBW) when it broke out above resistance, but we will be managing it carefully. Over the years, we have learned that consistently profitable traders are continually rewarded for patience and discipline.
Today’s Watchlist:
There are no new setups in the pre-market today, although we continue to stalk FXI and IGV for potential long entry.
Daily Performance Report:
Below is an overview of all open positions, as well as a performance report on all positions that were closed only since the previous day’s newsletter. Net P/L figures are based on the $50,000 Wagner Daily model account size. Changes to open positions since the previous report are listed in red text below:
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Open positions (coming into today):
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PBW long (900 shares from Feb. 20 entry) –
bought 18.54, stop 17.84, target 20.89, unrealized points = + 0.16, unrealized P/L = + $144
Closed positions (since last report):
-
QID long (500 shares from Feb. 20 entry) –
bought 51.83, sold 51.21, points = (0.62), net P/L = ($320)
Current equity exposure ($100,000 max. buying power):
- $16,830
Notes:
We took a shot at re-entering QID yesterday morning when the Nasdaq began to lose support of its short-term consolidation, but it quickly reversed. Fortunately, we trailed a tight intraday stop so that we were either “right or right out.” This provided us with a very high risk/reward ratio, despite getting stopped out. Per intraday e-mail alert, we also entered PBW long.
Edited by Deron Wagner,
MTG Founder and
Head Trader