Not surprisingly, stocks bounced from short-term oversold conditions yesterday, but the feeble rally attempt lacked momentum. The broad market moved higher in the first hour of trading, then subsequently drifted sideways throughout the rest of the session. The major indices finished the day modestly higher, but in the middle of their intraday ranges. The S&P 500 advanced 0.6%, the Dow Jones Industrial Average 0.4%, and the Nasdaq Composite 0.3%. Both the small-cap Russell 2000 and S&P Midcap 400 indices managed gains of only 0.1%. Considering that the previous day’s losses for the Russell 2000 and S&P Midcap 400 were 3.8% and 3.1% respectively, their 0.1% gains were rather insignificant, but at least the indexes avoided a second “down” day.
Turnover remained much higher than average yesterday, but failed to exceed to previous day’s blowout volume. Total volume in the NYSE declined by 6%, while volume in the Nasdaq was 9% lower than the previous day’s level. When stocks attempt to recover from a monstrous volume “distribution day” in the following session, it is normal for turnover to recede. Now that the market has slipped into correction mode, we will be on the lookout for higher volume “up” days that could indicate institutional accumulation. If the “accumulation days” were also preceded by lower volume “down” days, it is often a sign of an intermediate-term bottom. The quantity of higher volume down days (“distribution days”) is less relevant in a downtrending market. Although we are probably not even close to seeing an intermediate-term bottom from Tuesday’s sell-off, it’s helpful to know some underlying signs to look for in the coming weeks.
When stuck in a choppy, sideways range, we usually focus on trading the industry sector ETFs that are showing the most relative strength or weakness to the broad market. But when the major indices have entered into a high-momentum, steady trend in either direction, we prefer to trade the broad-based ETFs that track indexes such as the S&P 500, Dow, or Nasdaq. Since the trend has definitely shifted to the downside, we are now looking exclusively for short setups. Until recently, taking such bearish positions in an IRA or other non-marginable account was not possible because short selling requires a marginable account. But this is the perfect time to remind you about the new ProShares family of ETFs that are inversely correlated to the direction of the broad market. Rather than selling short the S&P 500 SPDR (SPY), for example, buying the ProShares Short S&P 500 (SH) gives you exactly the same position. If the S&P 500 drops 1%, SH will move approximately 1% higher (and vice versa). Even better for small trading accounts are the inversely correlated AND leveraged ProShares ETFs, known as “Ultra” ETFs. Like SH, the UltraShort S&P 500 (SDS) also moves in the opposite direction of the S&P 500, but at a leveraged ratio of 2 to 1. If the S&P 500 drops 1% today, SDS will gain approximately 2%. Be aware that trading the UltraShort ETFs requires a lot of discipline because they can just as easily work against you at the same ratio.
Until a few months ago, the ProShares family of inversely correlated and leveraged ETFs was limited to a few major indices such as the S&P 500, Dow Jones Industrials, Nasdaq 100, and the S&P Midcap 400, but the company recently expanded their offerings. In addition to market segments, they now offer UltraShort ETFs that track the major industry sectors, along with ETFs that are tied to various market styles like Value or Growth. If the market happens to enter a lengthy correction, the Short and UltraShort ETFs could become a real lifesaver to your non-marginable retirement accounts. As we see it, there is no longer a good reason to trade expensive, low-volatility ETFs such as SPY or DIA when you can tie up less buying power on a similar ETF that is margined at 2 to 1. This is why we bought the UltraShort Dow 30 ProShares (DXD) on Tuesday as opposed to selling short the DIAMONDS (DIA). The DIA trade would have realized a similar point gain as the 3.6 points we made in DXD, but the DIA trade would have tied up more than twice as much buying power AND would not have been possible in a retirement or other non-marginable account.
Yesterday, we looked at the long-term monthly chart of the S&P 500 in order to determine how low the current correction is likely to take the index in the coming weeks or months. While such analysis is great for knowing the “big picture” of where the market stands, the time horizon is too long to be helpful with support and resistance levels for short-term trades. For swing trades, we typically base our analysis on daily charts, then look at hourly and 15-minute intraday charts in order to fine tune the support and resistance levels. However, because Tuesday’s one-day losses were so large, the daily charts are no longer effective for determining short-term support and resistance because the S&P, Nasdaq, and Dow each collapsed well below both their daily uptrend lines and 50-day moving averages. The broad market’s uptrend from July was so rapid, so there is now very little in the way of horizontal price support levels from prior bands of consolidation. Conversely, the major indices would need to recover a vast majority of Tuesday’s losses in order to even test overhead resistance of their 50-day moving averages. When the daily charts become rather useless, we drill down to shorter-term hourly charts to find support and resistance levels. The hourly chart of the UltraShort S&P 500 ProShares (SDS) is illustrated below:
With the hourly charts, we use a 20-MA (brown line), 40-MA (teal line), and 200-MA (orange line). When a stock or index makes a clear break out of a range, as the major indices each did on Tuesday, we closely watch the 20-period MA on the hourly chart. When that moving average catches up to the price, it will often push the stock to new highs (in a breakout) or lows (in a breakdown). In the case of SDS, we will probably see the 20-MA on the hourly chart, presently at 58.35, catch up to meet the price of SDS within the next day or two. When it does, it will represent a low-risk long entry in anticipation of a resumption of its utprend (or downtrend in the S&P). If making such a buy entry, placing a protective stop below the 40-period moving average is ideal because the longer period moving average acts as even stronger support than the 20-MA.
If downside momentum in the market remains particularly strong, it is possible that SDS will move above Tuesday’s high (and the S&P below Tuesday’s low) before the 20-MA catches up. To protect against missing a substantial move, an alternative, albeit slightly higher risk entry point, would be above yesterday’s intraday consolidation. The blue horizontal line on the chart above marks that level of 59.90. Such an entry over $60 would require a stop below the 20-MA, but preferably still below the 40-MA. You could reduce your position size in order to accommodate the additional risk.
As we mentioned yesterday, it is unlikely that the market will quickly snap back this time. Way too much technical damage has been done to the charts. Therefore, continue to use any strength as a chance to unload any losing long positions you still haven’t sold. . . and don’t be stubborn! We really can’t stress enough the importance of not falling into “hope” mode with positions that may have violated your maximum loss parameters. On the short side, check out the complete list of inversely correlated and leveraged ETF offerings from ProShares. Take your pick of which major market index looks best for further downside (hint: they all look similar), then use the hourly charts in order to determine your entry and stop prices. Until you become familiar with trading these types of ETFs, we recommend keeping your share size on the light side so you don’t feel overly pressured.
There are no new pre-market setups today. As per the commentary above, we are stalking several of the ProShares UltraShort ETFs for potential entry. However, we first want to assess market conditions before determining whether to buy the breakout above yesterday’s consolidation, or the pullback to the 20-MA on the hourly chart. We will promptly send an intraday e-mail alert if/when we enter any new positions.
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:
Open positions (coming into today):
Closed positions (since last report):
Current equity exposure ($100,000 max. buying power):
We are currently flat.
Edited by Deron Wagner,
MTG Founder and