The Wagner Daily


Key breaks of closely-watched support levels in several of the major indices triggered a massive sell-off across the board yesterday. After gapping lower on the open, a reversal attempt in the Semiconductor Index ($SOX) helped stocks try to recover at mid-day. But the bears took control again in the afternoon, sending the broad market to new intraday lows. Small-caps got pummeled, as the Russell 2000 Index swooned 2.8%. The 2.3% loss in the S&P Midcap 400 Index wasn’t far behind. The S&P 500 plummeted 2.0%, the Nasdaq Composite 1.9%, and the Dow Jones Industrial Average 1.6%. All of the major stock indexes closed near their worst levels of the session.

On a technical basis, one of the worst things about yesterday’s selling spree was the accompanying surge in turnover. Total volume in the NYSE rushed 30% above the previous day’s level, while volume in the Nasdaq similarly jumped 22%. The 2.07 billion shares that traded hands in the NYSE was the highest volume day in the exchange since stocks formed their recent bottom in March. The sharply higher volume that accompanied yesterday’s losses caused both the S&P and Nasdaq to register another bearish “distribution day.” It was the third such day of institutional selling within the past five sessions. In yesterday morning’s commentary, we said that “The broad market has basically gone nowhere over the past four days, but a look “under the hood” at the volume patterns discreetly reveals underlying weakness. Because prices continue to hold up pretty well, negative price to volume relationships in the market are not solely enough justification to be bearish on the stock market. Nevertheless, professional traders who monitor underlying internals and volume patterns may begin hovering their fingers over the sell buttons in case prices begin to confirm the early warning signs.” Clearly, prices finally confirmed those early warning signs that volume patterns gave us in the preceding four days, causing lots of “sell” buttons to be pushed.

Market internals, particularly in the S&P, were about as nasty as could be. Declining volume in the NYSE crushed advancing volume by a margin of 14 to 1. The Nasdaq ratio was negative by a little more than 6 to 1. Further, the $TRIN reading in the NYSE was only 1.6. Levels above 2.0 to 2.5 are often considered extreme and unsustainable, but yesterday’s reading of 1.6 tells us the selling was steady, not indicative of massive panic selling. The bottom line is that, despite the bloodletting, market internals gave no sign of a short-term bottom yesterday.

The most obvious break of support in the broad market was the S&P 500’s collapse below its prior downtrend line, 20-day EMA, and the pivotal 50-day MA. This is illustrated on the daily chart below:

Although the S&P 500 dipped below its 50-day MA and recovered back above it several times last month, there is one big difference this time. Prior tests of the 50-day MA were not immediately preceded by a breakout to new highs. This time, the index has broken below its 50-day MA after breaking out to a fresh all-time high just several days ago. When a stock or index fails a breakout to a new high, the bulls who bought the breakout become trapped and are forced to quickly dump their shares. This typically leads to swift selling pressure, which in turn attracts the short sellers who see the failed breakout. Because yesterday’s break of the 50-day MA was preceded by a failed breakout to new highs, we would be quite surprised if the S&P 500 promptly snaps back to its highs this time, as it did during last month’s tests of the 50-day MA. As for support, the July 11 low of 1,506 is the first line of defense, while the June 27 low of 1,484 provides much more important support.

Both the Nasdaq and Dow fell below support of their 20-day EMAs yesterday, but are still above their more important 50-day MAs. Curiously, yesterday’s lows in both indexes coincides with pivotal price support of their respective prior highs. For the Nasdaq, it’s the June 20 high of 2,634, while the Dow’s prior high of 13,692 was posted on June 1. Dual support of those prior highs may give the broad market an excuse to bounce today, but any rally attempt is likely to fizzle out as long as the S&P remains below its 50-day MA. If the Nasdaq and Dow begin to fail their breakouts by falling below their June highs, support of the 50-day MAs is just below. For now, both of these indexes continue to look much better than the S&P 500. Conversely, the small-cap Russell 2000 is a major index that is looking much worse than the benchmark S&P 500.

Unlike the S&P 500, which failed its breakout to a new high, the Russell 2000 has shown so much relative weakness that it was unable to follow the S&P, Nasdaq, and Dow to new highs. When an stock or index fails to make new highs when the broad market does, it also becomes the first thing to collapse when the broad market eventually pulls back. The recent performance in the Russell is a good example of this.

After closing marginally below its 50-day MA on both July 20 and 23, the Russell completely fell apart yesterday. Not only did it slide 2.8% and close at a 3-month low, but the index also broke below support of its primary uptrend line that had been in place since July of 2006. This breakdown below the one-year uptrend line is shown on the weekly chart below:

Yesterday, the Regional Bank HOLDR (RKH) dropped several more points, hitting our original downside price target of $148.30. As such, we covered our short position into weakness for a gain of more than 8 points over a five-day period. Of the other four ETF positions, only the iShares Nasdaq Biotech (IBB) hit its protective stop. Since our trade setups always target a reward/risk ratio of at least 2 to 1, the capital gain from the RKH trade was double the loss of the IBB trade. Since two of the three remaining open ETF positions are not directly correlated to the direction of the stock market, they held up well yesterday. The CurrencyShares Canadian Dollar (FXC) is looking good, as it gapped to a new all-time high yesterday. The Market Vectors Gold Miners (GDX) pulled back a bit yesterday, but held support of its primary hourly uptrend line. Since FXC is correlated to the movement of the U.S. dollar and GDX is largely tied to the movement of the spot gold commodity, the actual stock market performance going forward is not a big factor for these positions. The PowerShares Clean Energy Fund (PBW) is indeed comprised of individual stocks, but this sector has been largely ignoring recent market dips because solar energy stocks are flaming hot (please excuse the cheesy pun).

As one might have surmised, yesterday’s weakness has changed our overall short-term bias on the market from bullish to bearish. As for the intermediate-term, we have shifted from bullish to a neutral bias, pending the outcome of whether or not the Nasdaq and Dow hold above their June highs. Yesterday’s action should lead to several ideal short setups in the coming days, specifically for those ETFs that rally into major prior support levels they just broke below. The iShares Russell 2000 (IWM) is one such ETF we will be stalking for a potential short entry. However, considering the broad market just fell two percent in one day, we are reluctant to list new short entries without waiting to see if the market at least attempts to bounce from here. Most of the large one-day drops in recent months were quickly followed up by substantial bounces.

Today’s Watchlist:

There are no new setups in the pre-market today. Per the above commentary, several ETFs that broke down yesterday may provide ideal short entries in the coming days. However, we are reluctant to provide pre-determined short entry prices without first assessing how the market responds to yesterday’s sell-off. As always, we’ll promptly send an intraday e-mail if we come across any low-risk entries during market hours.

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):

      GDX long (300 shares total – 200 shares from July 10, added 100 on July 17) –

      bought 40.76 (avg.), stop 41.18, target new high (will trail stop), unrealized points = + 1.64, unrealized P/L = + $492

      FXC long (250 shares from July 6 entry) – bought 95.51, stop 95.53, target new high (will trail stop), unrealized points = + 1.14, unrealized P/L = + $285

      PBW long (600 shares from July 18 entry) – bought 22.16, stop 21.13, target new high (will trail stop), unrealized points = (0.37), unrealized P/L = ($222)

    Closed positions (since last report):

      RKH short (100 shares from July 18 entry) – sold short 156.87, covered 148.46, points = + 8.41, net P/L = + $839

      IBB long (250 shares from July 13 entry) – bought 80.33, sold 78.65, points = (1.68), net P/L = ($425)

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



      Per intraday e-mail alert, we covered RKH as it neared our target. IBB was stopped out. Now that FXC has broken out to a new high, we have raised the stop to breakeven, just below support of its breakout level.

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    Edited by Deron Wagner,
    MTG Founder and
    Head Trader