Stocks followed through on last Friday’s late-day rally, albeit with quite a bit of intraday chop and indecision. The broad market opened flat, rallied in the morning, retraced most of the move at mid-day, then grinded its way above the morning high later in the afternoon. The Dow Jones Industrial Average gained 1.5%, the S&P 500 1.4%, and the Nasdaq Composite 1.1%. Relative weakness in large-cap tech stocks held the Nasdaq’s gain in check, but small and mid-cap stocks led the market. The small-cap Russell 2000 and S&P Midcap 400 indices climbed 2.1% and 2.0% respectively. Each of the major indices settled near their intraday highs for the second day in a row.
The most positive element of yesterday’s action is that the gains in the S&P and Dow were accompanied by volume that was 8% higher than the previous day’s level. However, total volume in the Nasdaq actually eased 8%. Despite the “accumulation day” in the NYSE, turnover in both exchanges remained below 50-day average levels. Volume in the NYSE has trickled in below average for eleven consecutive days, pointing to a continued reluctance on the part of institutional traders to place big bets on the market. We closely monitor the relationship between the stock market’s price and volume on a daily basis because more than half of the market’s average daily volume is driven by institutional activity. If institutions are buying, the market subsequently goes up. If they’re selling, it eventually goes down. Most of the time, it really is that simple. Volume is one of the few technical indicators that never lies or gives false signals, as the footprint of institutional trading is measured by changes in volume. When stocks rally on higher volume, institutions are buying, but it’s also important that turnover exceeds average levels. For many days now, it hasn’t.
Along with commodity ETFs, which we’ve traded and been discussing as market leaders for weeks, several ETFs in the Metals and Mining sector rose to new highs yesterday. The Market Vectors Steel Index (SLX), which has made an amazing recovery from its January sell-off, was one of them:
If a tight stop is placed just below the breakout level (the dashed horizontal line on the chart above), SLX could present a positive risk/reward ratio for long entry. If the broad market happens to get some momentum going on the long side, SLX should outperform. It should also be slower to fall than the major indices if stocks start heading back down. The S&P Metals and Mining SPDR (XME) also has a similar chart pattern.
Of similar correlation, the more diversified iShares Basic Materials (IYM) closed at a fresh all-time high as well. A rally above yesterday’s high should confirm the breakout. Note that volume also spiked well above average levels, confirming the institutional buying interest we like to see on breakouts:
As with SLX, one could enter IYM with a tight stop just below support of the breakout level (or below yesterday’s low) in order to have a positive risk/reward ratio on the trade. Between SLX and IYM, we like the IYM setup better because the base of consolidation (support) on the weekly chart is both tighter and more substantial. Volume in IYM over the past week has also been better than SLX, registering at least double its 50-day average level in each of the past four days. Regular subscribers should note our specific trigger, stop, and target prices for the IYM setup below.
The S&P 500 finally closed above the high of its two-week sideways range yesterday, but only nominally. This is obviously bullish on a technical level, but the index now faces major resistance of its 50-day moving average just overhead. While stocks have been trading sideways throughout most of the month, the 50-day MA has been drifting lower, closing in on the prices of the major indices. Given how difficult it was for the S&P to just overcome resistance of its 20-day MA, expect the 50-day MA to provide an even more powerful level of resistance. Further, resistance of the prior “swing high” from February 1 now converges with the 50-day MA, adding another layer of difficulty the S&P must contend with. This is illustrated on the daily chart of the S&P 500 below:
Another concern is the relative weakness in the Nasdaq Composite. Although the S&P closed above its 20-day EMA and the high of its recent range, the Nasdaq has not. Take a look:
Relative to the breakout in the S&P, yesterday’s action in the Nasdaq was pretty lame. If the Nasdaq does not quickly get in sync, the tech-heavy index is likely to be a major drag on the rally attempts of the S&P and Dow. Therefore, pay attention to the price action of the Nasdaq in the coming days. At the very least, the index needs to quickly pop back above both its 20-day EMA and last week’s high (over 2,353).
It’s positive that the S&P is breaking out of its recent range and a few more industries have moved to new highs, but negative factors such as low volume levels and relative weakness in the Nasdaq may counter the breakout. Overhead resistance of the 50-day MA is also a bit worrisome. Because of the mixed signals we’re seeing, our overall near-term bias has changed from bearish to neutral. However, we have no choice but to remain bearish on the the intermediate and long-term trends, at least until stocks prove otherwise by breaking out of their clearly established downtrends. Any counter-trend bounces should be played conservatively in share size and with tight adherence to pre-determined stop losses.
iShares Basic Materials (IYM)
Shares = 200
Trigger = 79.81 (above yesterday’s high)
Stop = 77.63 (below the breakout level and yesterday’s consolidation)
Target = new high (will trail stop)
Dividend Date = March 21, 2008
Notes = See commentary above for explanation of the setup. Note that we are also using a relatively tight stop, as we want to “be right or be right out!” Failed breakouts can reverse quickly, especially in bear markets. In the event of an opening gap above the trigger price, remember to use the MTG Opening Gap Rules to adjust the trigger price to 10 cents above the high of the first 20 minutes.
Overall, we still believe that odds favor the short side of the market more than the long side. However, with the S&P trying to break out, we don’t want to risk getting caught in another short squeeze similar to last Friday. We’ll continue stalking the market for short entries, but we’ll probably hold off until we see clear signs the buying interest has disappeared. In the meantime, dipping a toe in the water with a single long position at a new all-time high is a low-risk play.
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):
SDS long (300 shares from February 22 entry) – bought 64.40, sold 62.27, points = (2.13), net P/L = ($645)
Current equity exposure ($100,000 max. buying power):
SDS hit our original stop yesterday morning, so we are now flat.
Edited by Deron Wagner,
MTG Founder and