The Wagner Daily | June 13, 2007

Commentary:

The bulls and bears slugged it out yesterday, resulting in a volatile session that saw both parties assuming the upper hand throughout the day. The bears won in the end. After gapping lower on the open, the major indices trended lower throughout the first hour, reversed to new intraday highs by early afternoon, then turned tail and plunged below the morning lows into the close. The Nasdaq Composite lost 0.9%, the Dow Jones Industrial Average 1.0%, and the S&P 500 1.1%. The small-cap Russell 2000 fell 1.4%, while the S&P Midcap 400 declined 1.1%. As we often see in weak markets, all of the broad-based stock market indexes closed at their intraday lows.

The most negative factor of yesterday’s session was that volume once again surged higher. Total volume in the NYSE increased by 22%, while volume in the Nasdaq came in 27% above the previous day’s level. The market’s losses on higher volume caused both the S&P and Nasdaq to register bearish “distribution days” that were indicative of institutional selling. In the six days since the major indices peaked at their respective highs, there have been four “down” days and two “up” days. Higher turnover has accompanied each of the four “down” days, clearly showing “under the hood” that mutual funds, hedge funds, and pension funds have been supporting the recent selling. Conversely, both of the “up” days coincided with lighter volume, pointing to an unwillingness for institutions to buy stocks right now. The S&P 500 has had five “distribution days” in recent weeks, while the Nasdaq posted its eighth day of higher volume selling within the past five weeks. Even the strongest markets can rarely withstand more than four or five “distribution days” without subsequently leading to an intermediate-term correction.

On June 8, the S&P 500, Nasdaq Composite, Russell 2000, and S&P Midcap 400 indices each bounced perfectly off support of their 50-day moving averages, giving hope that stocks may have found support. But because of the overhead supply created from the previous three days of higher volume selling, we immediately cautioned in Monday morning’s commentary that, “the markets are likely to be choppy and volatile in the coming week.” Monday’s session was choppy, as stocks finished mostly unchanged. Yesterday’s action was both choppy and volatile as well. When the major stock market indexes are hanging out near pivotal areas of support or resistance, such as 20 or 50-day moving averages, intraday indecision usually results. Such is the current situation.

The solid gains of the June 8 bounce may have initially looked promising, but the major indices have already given back most of that day’s gains and dropped back down to their 50-day moving averages just two days later. As such, most of the major indices are once again at critical levels of support. Leading the way lower and the first index to close below its 50-day MA since the current uptrend began is the small-cap Russell 2000 Index. In just six days, the Russell has changed from being at an all-time high to trading below its primary uptrend line, 50-day moving average, and prior high from February. Sentiment sure can change quickly:

As it did four sessions ago, the broad-based S&P 500 has once again closed right at its 50-day MA. The difference this time, however, is that it will be the S&P’s second test of support in a short period of time. When coming off the highs of a steady uptrend, indexes and stocks rarely fall below their 50-day MAs on the first test of support. Because many institutions use the 50-day MA as a level at which to buy stocks, rallies usually follow the initial test of its support. As one might surmise, the odds of the 50-day MA continuing to provide support diminish with each subsequent test of that level. The shorter the period of time between each touch of the 50-day MA, the more likely the support will break. In this case, the bounce off the 50-day MA lasted only two days before the index rolled back over to close at that level. Rest assured, all eyes will be focused on whether or not the S&P 500 closes above its 50-day MA today:

Looking at the chart above, notice how the 20-day exponential moving average acted as resistance after the S&P’s initial bounce off the 50-MA. That remains a valid resistance point going into today. As for next support below the 50-day MA, expect the prior highs from February, illustrated by the dashed horizontal line, to help provide a bottom if the S&P breaks down further. That 1,461 level would be an ideal place to cover any remaining short positions and look to establish new long positions when the market confirms the correction is nearing an end.

Thanks to continued relative strength in the Semiconductor Index ($SOX), the Nasdaq is holding up slightly better than the other indexes. The Nasdaq gave back most of its June 8 gain yesterday, but is still nine points above its 50-day MA. There’s a good chance the index tests that level today, but it may show more resilience than the S&P and Dow. Notice how the Nasdaq is still above the lower channel of its multi-week trading range, which coincides with horizontal price support of the prior highs from February:

The Dow, which showed the most relative strength during the recent market uptrend, is still 138 points above its 50-day MA. It also remains nearly 4% above its prior high from February. Indexes and stocks with relative strength are often the last to correct, but they also have the furthest to fall when the inevitable pullback sets in. That is why we remain short the Dow, through the purchase of the inversely correlated UltraShort Dow 30 ProShares (DXD).

We now have four open short positions, but only one of them (DXD) is directly tied to a major stock market index. The others are ETFs with relative weakness or bearish chart formations like the “head and shoulders,” as they are likely to be less choppy than the broad-based ETFs, such as SPY, that are toying with their 50-day MAs. On the long side, we continue to stalk the Semiconductor HOLDR (SMH), which just missed our trigger price yesterday. Even in weak markets, it’s always wise to have at least one or two long positions with relative strength to hedge your short positions. The semiconductor sector should lead the way higher when the market eventually finds sustainable support.

Today’s Watchlist:

SMH – Semiconductor HOLDR
Long

Shares = 500
Trigger = 36.81 (above the downtrend line)
Stop = 36.04 (below the 50-day MA and 61.8% Fibo retracement)
Target = new 52-week high (will trail stop)
Dividend Date = Regular distribution on individual stock basis

Notes = We scratched this trade last week when it failed to hold above its 20-day EMA. Since then, SMH has dipped below its 50-day MA and shaken out the “weak hands,” but bounced back sharply on Friday. It is now back above its 20-day EMA and poised to break out above its newly anchored downtrend line. If it does, we will buy it. As previously discussed, it is wise to currently be positioned on both sides of the market, long the ETFs with relative strength, and short those with relative weakness. Given last Friday’s impressive performance that followed an “undercut” below the 50-day MA, SMH is now one of the best looking sectors on the long side.

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):

unrealized P/L = + $460

DXD long (250 shares from June 6 entry) – bought 50.00, stop 49.59, target 53.88, unrealized points = + 1.44, unrealized P/L = + $360

EWO short (300 shares from June 6 entry) – sold short 40.77, stop 41.13, target 37.75, unrealized points = + 1.18, unrealized P/L = + $354

EWW short (200 shares from June 12 entry) – sold short 61.97, stop 64.39, target 55.10, unrealized points = + 0.55, unrealized P/L = + $110

Closed positions (since last report):

Current equity exposure ($100,000 max. buying power):

$49,271

Notes:

We raised the target price on DXD to just below the 38.2% Fibonacci retracement from the March high down to the June low. If DXD gets above its 50-day MA, momentum should carry it at least to that level.

The SMH long setup missed our trigger price again, but remains on our watchlist due to its relative strength. Note the new trigger price, just above yesterday’s high, as well as the slightly increased share size. When the market eventually reverses higher, SMH should be one of the strongest ETFs. It’s a good long position to be hedged with, but no sense buying it until it breaks out above the downtrend line. If it doesn’t trigger, there was no harm in stalking it for potential entry.

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Edited by Deron Wagner,
MTG Founder and
Head Trader