As anticipated, divergent chart patterns amongst the major indices led to a choppy, indecisive session yesterday, but the Nasdaq bulls got the upper hand by the closing bell. Broad market price action resembled a roller coaster, as stocks rallied on the open, sold off at mid-day, then reversed again in the final ninety minutes of trading. The Nasdaq Composite climbed 1.5%, but the S&P 500 and Dow Jones Industrial Average bounced just 0.7% and 0.6% respectively, relatively small gains considering the extent of last week’s losses. The small-cap Russell 2000 gained 1.4%, as the S&P Midcap 400 advanced 0.8%. All the main stock market indexes closed near their intraday highs.
Curiously, turnover declined across the board yesterday. Lighter volume could be expected ahead of the past holiday weekend, but trading activity usually picks up immediately after a holiday has passed. Not this time. Total volume in the NYSE eased 6%, while volume in the Nasdaq came in 2% below the previous day’s level. Higher turnover would have pointed to accumulation by mutual funds, hedge funds, and other institutions, but they stayed on the sidelines instead. Considering it was the first rally attempt following last week’s large losses, it’s bearish that institutions showed no signs of buying interest yesterday. Low-volume bounces within the context of a primary downtrend often come unraveled easily.
Not surprisingly, the Philadelphia Semiconductor Index ($SOX) moved higher, triggering our long entry into the Semiconductor HOLDR (SMH), which we analyzed in yesterday’s commentary. As per the pre-market plan, we bought SMH when it rallied above the previous day’s high, less than ten minutes after the open. After the initial opening strength, SMH lacked the kind of momentum we hoped to see, but still finished just a few cents below its high of the day. Again, we’re viewing this as just a very short-term momentum trade with a price target of its prior high from May 19. Overall market conditions are simply too weak to expect much more. Although we’re showing a small unrealized gain on the trade, we’ve trailed our protective stop higher, to just below yesterday’s low, in order to minimize risk if the rally quickly fizzles out. Separately, we locked in a 3-point gain on the UltraShort Dow 30 ProShares (DXD) yesterday, which we sold due to an anticipated bounce in the Nasdaq.
After scanning the chart patterns of hundreds of ETFs, we came across very few bullish chart patterns with a positive reward/risk ratio. Again, many of yesterday’s gainers merely bounced from the lower channel support of their new downtrending channels. None broke out to a new high, although a few sectors such as oil, mining, and steel are still trading near their 52-week or all-time highs. One ETF that still has a very bullish chart pattern is Market Vectors Russia (RSX). Best of all, it has a relatively low correlation to the direction of the U.S. stock market because it’s an international ETF. Below is its daily chart:
As you might recall, we traded RSX after it broke out two weeks ago. Rather than holding RSX, we took the profit quickly because our entry to the breakout was a little later than we would have preferred. However, since then, we’ve been monitoring its price action, waiting for a decent pullback. With the formation of a bullish “hammer” candlestick on its daily chart, buying RSX above yesterday’s high presents us with a positive reward-risk ratio for the setup. Drilling down to the shorter-term hourly chart of RSX, you will see that a rally above yesterday’s high also correlates to a breakout above the short-term hourly downtrend line. When strongly trending ETFs undergo a normal correction, the breakout above the hourly downtrend line typically represents the ideal buy point to anticipate a resumption of the primary uptrend. The blue descending line on the chart below marks the hourly downtrend line (standard moving averages have been removed so you can more easily see the trendline):
On the surface, yesterday’s gain in the Nasdaq may seem encouraging, but a closer look at yesterday’s action reveals unimpressive performance. Aside from the lighter overall volume, the biggest problem is that most leading individual stocks showed no signs of life yesterday. Instead, many of the top-gaining stocks were those with mediocre chart patterns, in industry sectors that were merely bouncing from positions of weakness. It was hardly the kind of leadership necessary to power the market higher. Although that situation could improve in the coming days, we trade what we see, not what we think. Based on what we saw yesterday, the absolute percentage gains of the major indices may have hinted at strength on the surface, but a look “under the hood” of the market shows a different picture altogether.
The Nasdaq perfectly bounced off support of its intermediate-term uptrend line, but it feels like the reversal may be short-lived. One of the reasons we feel this way is because the index is now forming the right shoulder of a bearish “head and shoulders” chart pattern. The components of this pattern are labeled on the daily chart below (moving averages have again been removed):
With its right shoulder now being formed, the Nasdaq may run into substantial resistance around the 2,500 level, which corresponds to the high of the left shoulder. Additional resistance of the 200-day MA is at the 2,513 level (not shown). Though the Nasdaq continues to show the most relative strength of the major indices, it’s starting to look like the index may soon run into trouble as well. This is why we suggested that any new long entries made yesterday (such as our SMH position) be entered with a very short projected time horizon. Nevertheless, we like the idea of having at least one or two long positions on, just in case the Nasdaq happens to rip higher, thereby failing to follow through on its head and shoulders pattern. As long as tight stops are trailed along the way, it’s not a bad idea to participate in the strength of the Nasdaq bounce while it lasts.
As for the benchmark S&P 500, it’s still in worse shape than the Nasdaq. Although the S&P bounced off support of its 50-day MA yesterday, it now must contend with a plethora of overhead supply left behind in the wake of last week’s sell-off. Going into today, expect prior support of the May 9 low to now act as new resistance. Since the S&P closed right at that level yesterday, stocks could face a bit of a struggle moving much higher today. The blue-chip Dow Jones Industrials has a much bigger problem because it’s now stuck below its 50-day moving average, trying to prevent free-falling down to its March lows. With minimal technical support below the current price of the Dow, it would not be surprising if such a downward move happened within the next several weeks. If the Dow starts leading the way lower again, we’ll probably re-enter the UltraShort Dow 30 ProShares (DXD), especially if the Nasdaq gets in sync with the broad-based weakness as well. Also on the short side, we’re monitoring the oil and oil service ETFs, as we’ve suddenly begun to see some distribution in the energy sector.
Market Vectors Russia (RSX)
Shares = 350
Trigger = 56.64 (above convergence of yesterday’s high and hourly downtrend line)
Stop = 55.39 (below yesterday’s low)
Target = new high (will trail stop)
Dividend Date = n/a
Notes = See commentary above for explanation of the setup. Note we have set our share size to limit initial capital risk to just over $400, about 40% less than usual risk, as we don’t want to be too aggressive on the long side of the market right now.
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 hit our tight trailing stop, enabling us to net a profit of more than $1,000 in the model portfolio.
- Yesterday’s SMH setup triggered for long entry. We have already raised the stop to limit our risk to just $300 in the event of a reversal below yesterday’s low. If it retraces that far, we don’t want to be long anymore because such a sell-off would put SMH back below its 20 and 200-day moving averages.
- GLD pulled back a bit, but is trying to hold support of its 20 and 50-day moving averages here. In the event of an opening gap down below our stop price, remember to use the MTG Opening Gap Rules to manage the position. New stop would automatically be adjusted to 10 cents below the low of the first 20 minutes.
GLD long (250 shares from May 15 entry) – bought 87.33, stop 88.52, target 93.20, unrealized points = + 2.03, unrealized P/L = + $508
SMH long (600 shares from May 27 entry) – bought 32.33, stop 31.83, target 34.15, unrealized points = + 0.25, unrealized P/L = + $150
Closed positions (since last report):
DXD long (350 shares from May 7 entry) – bought 50.79, sold 53.77, points = + 2.98, unrealized P/L = + $1,036
Current equity exposure ($100,000 max. buying power):
Edited by Deron Wagner,
MTG Founder and