Resistance of the 50-day moving averages on the S&P and Dow “did its thing” yesterday, causing stocks to pull back and retrace several days of gains. The broad market gapped down on the open, then drifted sideways to modestly lower throughout the rest of the day. The S&P 500, Dow Jones Industrial Average, and Nasdaq Composite posted identical losses of 0.9%. The tech-heavy Nasdaq 100 Index dipped just 0.3%, but the small-cap Russell 2000 tumbled 1.5%. The S&P Midcap 400 was lower by 1.0%. All the major indices closed in the bottom third of their intraday ranges.
Total volume in the NYSE was on par with the previous day’s level, while volume in the Nasdaq trickled in 7% lighter. In both exchanges, declining volume firmly exceeded advancing volume by a margin of approximately 3 to 1. It’s now been fifteen trading days since trading in the NYSE exceeded 50-day average levels. This merely tells us institutions have remained primarily on the sidelines throughout the stock market’s choppy, range-bound action over the past several weeks. Who can blame them? Overtrading in the current market environment is a surefire way to churn your account. This, of course, makes your broker happy, but can make you broke. Volume should pick up, making it easier to profit, when the broad market eventually breaks out of its recent range in one direction or the other.
Will yesterday’s correction lead to further losses in the near-term, or was it merely a one-day breather within the context of the stock market’s recovery off the January lows? The answer to that question may depend on the direction of financial stocks in the coming days, for it was a recovery in the banking sector that sparked the broad market’s bounce in late January. Take a look at the daily chart of the Banking Index ($BKX) below:
Although the $BKX staged an impressive rally in late January and moved back above its 50-day moving average, the index has been stagnant for the past three weeks. The $BKX is trying to cling to support of its 50-day moving average, but check out yesterday’s action. After a feeble rally attempt and just a few days above the 50-day MA, the index got slammed yesterday, dropping 3.5%. It’s still technically holding support of its recent range, but a firm close below the February 22 low (the dashed horizontal line) could lead to substantial downward momentum. Bulls who bought the recent consolidation in anticipation of further gains will be forced to sell, which in turn will attract the attention of short sellers. If the $BKX breaks down in the near future, it will surely drag down the main stock market indexes as well. A break of the February 22 low in the $BKX could easily lead to a test of its January lows. The same could be said of the S&P and Dow.
In yesterday’s Wagner Daily, we used an overlay chart to illustrate the bullish divergence that the iShares Silver Trust (SLV) was showing over the StreetTRACKS Gold Trust (GLD). We said that the relative strength would have first become apparent on February 22 if comparing charts of the various sectors on a daily basis. One real-time example of spotting divergence from the S&P 500 when it first becomes apparent, not in hindsight a week later, can be found on the hourly overlay chart of the $BKX that we discussed above. Below is an hourly chart that compares the percentage changes of the $SPX and $BKX over the past week:
Notice how the Banking Index (the red line) was basically following the direction of the S&P (the blue line) until yesterday. Suddenly, the $BKX has begun to show major relative weakness, dropping 2.5% more than the S&P 500 yesterday alone. When big divergence such as this is spotted, it can be acted on with a low degree of risk because the divergent trend usually becomes even greater in the days that follow. The same thing happened to SLV, as it first showed relative strength to GLD on February 22, then began to outperform by a much wider margin in the days that followed. In this case, we expect the newfound relative weakness in the $BKX to begin intensifying over the next week.
If the $BKX breaks support of its three-week range and continues showing relative weakness to the S&P 500, there are several ETFs that could offer profitable opportunities. Closely mirroring the pattern of the actual $BKX index, the Regional Bank HOLDR (RKH) could be sold short. A lower-priced, lower volatility alternative is to sell short the S&P Financial SPDR (XLF). If you have a non-marginable cash account such as an IRA, buying the UltraShort Financial ProShares (SKF) is your best bet.
We’ve been in and out of SKF three times this month. We netted a gain of 4.85 points on the first entry, then lost a combined total of 6.57 points between the two subsequent entries. Because SKF is quite volatile, a net loss of 1.72 points between the three trades is only slightly worse than a scratch. Our most recent entry in SKF was on February 22, when it rallied above the high of its multi-week range. Though the trade looked good at the time of entry, a wild, broad-based rally in the final thirty minutes of trading caused SKF to fail its breakout and hit our stop the same day.
Despite our recent “false start” in SKF, one can’t be afraid to re-enter a position just because the previous trade resulted in getting stopped out. In fact, our most profitable trades are often those that we initially stopped out of because we were just a bit early. After all the “weak hands” are gone, the trade will often rip in the intended direction. With such relative weakness in the banking sector now making itself clear, this may be the time to re-enter SKF. On the daily chart below, notice that SKF is now poised to break out above its steep downtrend line from the January high. The shakeout below the 50-day MA in which many stops were hit over the past two days is actually bullish; all the “weak hands” who wanted out are now gone:
Yesterday, we bought the UltraShort Dow 30 ProShares (DXD) when it rallied above both the February 27 high and its 50-day MA. Our stop is below the low of this week’s range. Gold and silver ETFs continued to zoom higher yesterday, with silver continuing to show relative strength. The potential bull reversal we pointed out in the iShares Xinhua China 25 (FXI) did not trigger, so one should stay away from FXI until it confirms the trend reversal by rallying above convergence of its 50-day MA, 200-day MA, and four-month downtrend line. iShares Brazil (EWZ) held near its high.
We are targeting SKF for potential entry over yesterday’s high and its daily downtrend line. However, because the S&P futures are positioned for a lower start in today’s session, we will look for an entry point in the morning and send an e-mail alert, rather than listing a trigger price in the pre-market. A gap down in the broad market will only cause SKF to gap open above yesterday’s high, forcing us to use the MTG Opening Gap Rules and adjust any pre-market trigger price anyway. We’ll promptly send an e-mail alert with trade details if/when we buy SKF today.
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):
DXD long (400 shares from February 28 entry) – bought 54.84, stop 53.22, target 59.85, unrealized points = + 0.19, unrealized P/L = + $76
Closed positions (since last report):
Current equity exposure ($100,000 max. buying power):
The pre-market DXD setup triggered as per the original plan. No changes to the stop at this point.
Edited by Deron Wagner,
MTG Founder and