Stocks attempted to build on the previous day’s gains yesterday morning, but reversed course as the S&P 500 neared resistance of its 50-day moving average in the afternoon. Each of the major indices settled flat to modestly lower. The S&P 500 was unchanged, the Dow Jones Industrial Average slipped 0.1%, and the Nasdaq Composite declined 0.2%. The small-cap Russell 2000 fell 0.6%, but the S&P Midcap 400 lost only 0.1%. Intraday price action between the main indexes was divergent and choppy. While the Nasdaq closed near its low, the S&P 500 finished just below the middle of the day’s range. The other major indices concluded the indecisive session in the bottom third of their intraday ranges.
Total volume in the Nasdaq rose 9%, causing the index to register a bearish “distribution day.” Turnover in the NYSE, however, was on par with the previous day’s level. The Nasdaq has closed lower in four of the past six sessions. Three of those four “down” days were higher volume “distribution days.” Though the Nasdaq has been showing the most relative strength since the recovery off the August 16 low, the recent price to volume patterns have turned negative. The S&P has similarly had two “distribution days” within the past six sessions. Nevertheless, volume levels in both exchanges have come in below average for the past seventeen consecutive days. This tells us institutions are not yet rushing for the exit doors, but they’ve had a slight bias to the sell side since the September 4 broad market peak.
Although both the S&P 500 and Dow Industrials broke out above their hourly downtrend lines two days ago, they are now forming the right shoulders of bearish “head and shoulders” chart patterns. On the hourly charts below, we have labeled the components of the “head and shoulders” patterns:
Comparing the S&P and Dow charts, notice that the “neckline” on the S&P is slightly ascending. The “neckline” on the Dow, however, is almost perfectly horizontal. This tells us that the S&P showed slightly more relative strength than the Dow during the recent pullback to the “neckline.” However, the S&P is not much stronger than the Dow because both indexes are showing “right shoulders” that are nearly equivalent to the height of their “left shoulders.”
Based on the formation of the “right shoulders,” the next anticipated move is another retest of the “necklines.” If the indexes break below their “necklines,” the patterns will have been validated and are likely to follow through. If that happens, the projected downside price target for either index is equal to the distance from the top of the “head” down to the “neckline.” For the S&P 500, that equates to a predicted downside move of about 55 points below the neckline. Subtracting 55 points from the neckline of approximately 1,440 gives us a predicted downside target around 1,385, just above the August 16 low. Saving you the math work, the Dow has a projected downside target of around 12,550. Of course, both indexes must first break below their necklines in order for the chart pattern to be validated.
Due to the “head and shoulders” formations shown above, the risk/reward ratio of selling short the S&P and/or Dow (or buying their inversely correlated ETFs) is now pretty good. If entering short positions near yesterday’s closing prices, protective stops could be placed above yesterday’s highs. Even better is to give the setup a little more “wiggle room” by placing your stop just above the top of the “head” in either index. The latter would obviously entail more risk, but also reduces the chance of getting shaken out in this choppy environment. This is especially true considering that convergence of the 50-day MAs and intermediate-term downtrend lines in both the S&P and Dow is right above yesterday’s highs:
Confluence of the 50-day MA and intermediate-term downtrend line on the daily charts is, in and of itself, a pretty decent reason to initiate a short position in the S&P or Dow. The “head and shoulders” patterns on the hourly charts further put the odds of a profitable short sale in one’s favor.
When entering any new trade, long or short, it’s obviously impossible to definitively know the outcome of the trade. Rather, all we can do is take the trades in which the odds are stacked in our favor. This is one such scenario, though support of the 200-day MAs below might put up a battle again. We’re already short both the S&P and Dow from their reversals off their 50-MAs a few days ago, but current levels are equally attractive for new short entries.
There are no new setups in the pre-market. However, we are stalking OIH for a potential long entry on a breakout above its September 6 high. We will send an intraday e-mail alert if/when we enter. GLD continues to act great, but has not yet consolidated enough to give us a low-risk entry point. As always, 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):
IBB long (250 shares total – bought 200 shares on Aug. 31, added 50 on Sept. 7) –
bought 79.62 (avg.), stop 78.89, target 83.30, unrealized points + 2.27, unrealized P/L + $568
LQD long (350 shares from August 31 entry) – (see notes below regarding dividend distributions)
bought 104.99 (avg.), stop 103.53, target 107.48, unrealized points + 0.00, unrealized P/L + $0
DXD long (300 shares from September 5 entry) – bought 51.42, stop 49.38, target 56.90, unrealized points (0.28), unrealized P/L ($84)
SDS long (250 shares from September 7 entry) – bought 56.12, stop 53.74, target 62.89, unrealized points (1.62), unrealized P/L ($405)
Closed positions (since last report):
Current equity exposure ($100,000 max. buying power):
No changes to the open positions above. Note that open P/L for DXD is based on the 4:00 pm closing price, as a rogue trade after-hours caused it to “officially” close 50 cents below where it actually should have finished.
On September 4, LQD traded ex-dividend, with a dividend distribution of 49 cents per share. Unrealized points and P/L figures include this distribution, which will be paid out on September 10.
Edited by Deron Wagner,
MTG Founder and