Stocks shook off early weakness to close firmly higher yesterday, but a wave of selling in the final hour caused traders to lose a bit of enthusiasm. The S&P 500 gained 0.6%, the Dow Jones Industrial Average 0.7%, and the Nasdaq Composite 1.0%. Small-caps acted well, enabling the Russell 2000 to advance 1.3%. The S&P Midcap 400 was higher by 0.8%. All the major indices finished slightly above the middle of their intraday ranges, pointing to a tug-of-war into the closing bell.
Total volume in both the NYSE and Nasdaq increased 10% above their respective levels of the previous day. It was the highest volume day in the Nasdaq in more than a month, and turnover also exceeded its 50-day average level. Technically, both the S&P 500 and Nasdaq Composite registered another bullish “accumulation day” yesterday. However, a closer look “under the hood” reveals trading actually picked up the pace during the late day bearish reversal. This points to stealth institutional selling into strength.
The CurrencyShares Euro Trust (FXE), which follows the price of the euro compared to the U.S. dollar, broke out to another all-time high two days ago. This time, however, the strength was short-lived. Just one day after breaking out, FXE fell back to its previous range, then followed up with a sharp drop below its 20-day exponential moving average yesterday. The closing price below the 20-day EMA was the first since back in mid-February of this year. When a stock or ETF breaks out to a new high, but falls all the way below its 20-day EMA just two days later, it’s a bearish signal known as a “false breakout.” This occurs because the bulls who (quite properly) bought the breakout become trapped and are forced to quickly sell their positions. This, in turn, attracts the interest of short sellers, which intensify the downward selling pressure. False breakouts are often one of our most profitable types of short entries. Be aware, however, that disciplined stops are required just above the highs because ETFs that false breakout occasionally reverse and rip much higher when they don’t immediately follow through to the downside. The false breakout and subsequent bearish reversal of FXE is shown on the daily chart below:
Selling short FXE is obviously one way to take advantage of the bearish reversal in the euro. A similar way is to simply buy the PowerShares U.S. Dollar Index Fund (UUP), which moves up as the U.S. dollar strengthens against an index of foreign currencies around the world. With UUP, a rally above yesterday’s high would also correspond to a breakout above its 50-day MA. Note that spot gold and silver ETFs (such as GLD and SLV), which tend to trade inversely to the direction of the dollar, may also be good short candidates if they lose support of their April 1 lows.
The Nasdaq Composite finally moved above its February 2008 high yesterday, but pivotal resistance of the February high is still presenting a challenge to the S&P 500. On an intraday basis, the S&P probed above its February high, as well as the high of its week-long consolidation, but selling in the final hour of trading caused the index to close below both levels. It’s positive that the Nasdaq joined the Dow in moving above its prior high from February, but it’s psychologically important for the S&P to follow suit because it is such a broad-based index. The dashed horizontal line on the daily chart below marks that troublesome resistance level the S&P 500 must soon overcome, or else face the strong possibility of a major sell-off:
After the broad market sold off on April 22, we suggested stocks would at least attempt to make another leg up before confronting any major selling pressure. Specifically, we anticipated at least a test of the long-term downtrend lines that began with the highs of October 2007. Only after attracting the “late to the party Charlies” who finally decide to buy several weeks too late, as well as running the last of the short sellers out of the market, is when we said the stock market would likely resume its bearishness that has been in effect for the past six months.
The Dow Jones Industrial Average has already rallied enough to kiss its weekly downtrend line, while the S&P 500 and Nasdaq Composite are close enough they can reach out and touch them. The Nasdaq Composite’s closing price above last Friday’s high, combined with the S&P 500’s attempted close above last Friday’s high, means we have technically already seen the additional leg up that we suggested a few days ago. But since the S&P 500 traded above its February high on an intraday basis, but failed to close above it, a drop below yesterday’s low would now be bearish. If the index moves below yesterday’s low in today’s session, it would also be typical action of a false breakout (similar to the false breakout in FXE above). If that occurs, we will begin reverting back to the short side of the market because there’s no guarantee the S&P 500 and Nasdaq Composite actually have enough momentum left to even touch their weekly downtrend lines before heading south again. We feel that short sales in the broad-based ETFs, or the purchase of inversely correlated ETFs, now carry a good reward/risk ratio. However, be sure to first wait for a break of yesterday’s lows, in order to confirm the bearish reversal.
Until the S&P 500 convincingly rallies above its horizontal price resistance (above the 1,400 level), we’re holding off on new long entries. The DB Commodity Index Tracking Fund (DBC) has not yet broken out above its range and has been temporarily removed from our buy watchlist. Although advanced traders may consider daytrading the newfound relative strength in the semiconductor sector (or even QQQQ), we don’t like any of the ETF setups enough to buy for new “swing trades.” We’ve been flat for the past two days, patiently waiting for the next ideal trade setups. A full cash position makes it easy to be nimble, quickly following the direction of the stock market’s next clear move.
UltraShort S&P 500 ProShares – SDS
Shares = 300
Trigger = 59.41 (above the three-day high)
Stop = 56.78 (below the recent consolidation and 200-day MA)
Target = 64.60 (approx. 50% Fibonacci retracement from the March high down to April low)
Dividend Date = June 2008
Notes = Rather than selling short SPY, we are looking to buy the inversely correlated UltraShort S&P 500 ProShares (SDS) if the S&P 500 moves below yesterday’s low. This would obviously be equivalent to SDS moving above yesterday’s high.
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):
Current equity exposure ($100,000 max. buying power):
Our DBC setup did not trigger and has been removed from our watchlist. We remain flat going into today.
Edited by Deron Wagner,
MTG Founder and