Commentary:
Curiously following the previous day’s reversal pattern, the Feds announced a surprise rate cut last Friday morning that sparked a broad-based rally. The S&P 500 zoomed 2.5% higher, the Nasdaq Composite 2.2%, and the Dow Jones Industrial Average 1.8%. The small-cap Russell 2000 and S&P Midcap 400 indices gained 2.2% and 2.1% respectively. Based purely on the percentage gains, one might assume it was quite a bullish day, but the intraday price action of the broad market actually left a lot to be desired. The major indices marked their highest levels of the day on the opening gap, then subsequently fell to nearly unchanged levels just ninety minutes later. Buyers gradually returned later in the day, but the main stock market indexes still closed below their opening prices and barely in the upper third of their intraday ranges. Overall, one could reasonably suggest it wasn’t a very convincing day, especially considering the typical bullish reaction that a surprise half-point rate cut would generate.
Perhaps the biggest problem with last Friday’s action was the lack of higher volume that should have accompanied the follow-through of Thursday’s bullish reversal day. Total volume in the NYSE dropped 17% below the previous day’s level, while volume in the Nasdaq came in 21% lower. The lower turnover across the board prevented both the S&P and Nasdaq from scoring an “accumulation day” that might have signalled the return of institutional buying. In fairness though, recall that the prior day’s trading was among record high levels. Nevertheless, Friday’s large price gains on declining volume tell us that Friday’s session may have been driven by short covering, as opposed to solid institutional demand for new long positions.
The question on the minds of many traders and investors over the weekend was whether or not the positive reaction from the rate cut will be sustainable for more than a few days. Some traders have even suggested the Fed move will actually have negative consequences for the stock market in the intermediate-term. On a fundamental basis, we have no opinion on the implications of the rate cut. Rather, we are relying on technical analysis to guide us, just as we have always done. Since the major indices are already several percent above the intraday lows of August 16, let’s take a look at the key resistance levels we can expect the S&P, Nasdaq, and Dow to test in the coming week. First, check out the daily chart of the benchmark S&P 500 Index:
The two most pivotal resistance levels the S&P may test in the coming days is its 200-day moving average and the upper channel resistance of its intermediate-term downtrend line. On the chart above, the thick orange line marks the 200-day MA, while the descending red line is the upper channel of its current downtrend. If you have any long positions you wish to sell into strength, consider doing so on a rally to the area between the 200-day MA and primary downtrend line (circled in blue). If the S&P happens to blow through its downtrend line, you can always re-enter your long positions. But until that happens, we must assume the current downtrend will continue until the S&P proves otherwise. As you can see below, the Nasdaq Composite also faces resistance of its intermediate-term downtrend line:
Because the Nasdaq showed more relative strength than the S&P 500 on the way down, it has already recovered above its 200-day MA. However, the big area of prior price congestion at current levels is full of overhead supply the index will need to absorb in order to hold steady. The primary downtrend line also looms overhead. Finally, take a look at the Dow:
Having shown even more relative strength than the Nasdaq when the market began its correction, the Dow has not yet even closed below its 200-day MA. Still, there is a lot of overhead resistance. Specifically, the 50-day MA has converged with the primary downtrend line, which will make that level twice as difficult to get through.
In the August 17 issue of The Wagner Daily, we said of the previous day’s bullish reversal that “we honestly cannot recommend buying any stocks or ETFs until the market proves that yesterday’s reversal wasn’t just a fluke to suck in the bulls. With downward momentum so strong, it remains quite risky to be on the long side of the market. As for shorts, you probably want to stay clear of those as well, at least until we see how far the market retraces before running out of gas again.” As we enter the new week, our sentiment remains exactly the same.
Sure, last Friday’s action was a welcome relief from the downward pressure, but it was not the type of convincing follow-through that would get us excited to start buying again. Since the major indices closed below that day’s opening highs, it remains to be seen whether or not the gap up was just a knee-jerk reaction that will quickly fade into the sunset. Due to vast levels of overhead resistance in the broad market, we should begin to see the formation of new short setups within the next 1 to 3 days. If the main stock market indexes break out above their downtrend lines, our negative short and intermediate-term biases might change, but there’s not point discussing that until it happens. For now, we remain “flat and happy,” patiently waiting for the next clear trade setups to present themselves.
Today’s Watchlist:
There are no new trade setups for today. Now that the market has begun to bounce into major resistance levels, we’ll be looking for new short setups to come across our radar screen. Specifically, we are looking for setups that provide us with a higher than average risk/reward ratio (potential loss compared to potential gain). If we enter anything new today, we’ll promptly send the details via intraday e-mail alert. As for quick, momentum-based long entries, we’d stay clear of those at this point. It was not a bad bet to enter a few during last Thursday afternoon’s bullish reversal, but the risk/reward of new long entries at current levels is not good.
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):
-
(none)
Closed positions (since last report):
-
(none)
Current equity exposure ($100,000 max. buying power):
- $0
Notes:
As per the plan, we remain “flat and happy.”
Edited by Deron Wagner,
MTG Founder and
Head Trader