Stocks wrapped up the week on a positive note last Friday, as the major indices recovered some of the previous day’s steep losses. After moving higher on the open, the main stock market indexes drifted sideways, in a tight range, throughout the rest of the day. The Nasdaq Composite reclaimed more than half of last Thursday’s loss by gaining 1.3%. The advances in the S&P 500 and Dow Jones Industrial Average were less impressive; the benchmark indexes climbed 0.4% and 0.2% respectively. The small-cap Russell 2000 rallied 1.1% and the S&P Midcap 400 ticked 0.4% higher. Bullish divergence caused the Nasdaq to close near its best level of the day, but the rest of the major indices settled near the middle of their intraday ranges.
Turnover backed off substantially, indicating traders were hesitant to hold a bunch of long positions over the weekend. In both the NYSE and Nasdaq, total volume declined 20% below the previous day’s levels. Trading in both exchanges also fell to below average levels. Advancing volume in the Nasdaq exceeded declining volume by a respectable margin of 2 to 1. The adv/dec volume ratio in the NYSE was flat.
Last week, we discussed the major change of sentiment that has caused the various commodity-based ETFs to get pummeled in recent weeks. The U.S. Natural Gas Fund (UNG), for example, has plunged a whopping 33% so far this month! It also sliced through its 200-day moving average last week, without even bouncing on the initial test of support. Frankly, it is pretty unusual for any ETF to so easily violate such a major support level on the first test. The loss in crude oil, and the U.S. Oil Fund (USO), has been less dramatic. Still, USO has been trending sharply and steadily lower since mid-July. The strength of the downtrend is evidenced by the fact that USO has remained below its 20-period exponential moving average on the hourly chart since the current sell-off began on July 15. On a relative basis, gold (GLD) and silver (SLV) have held up much better than oil and gas, but both failed their recent breakout attempts, forcing us to revoke our bullish bias toward the precious metals.
One logical reason for the sharp decline in the prices of these ETFs is simply a correction to the extraordinary gains that many commodities racked up in such a short period of time. The faster stocks and ETFs go up, the faster they tend to come down. . .whenever they eventually correct. But another factor that has been heavily influencing the prices of the commodities is the recent strength in the U.S. dollar. Generally speaking, commodities have had an inverse relationship to the price of the U.S. dollar. To illustrate the strengthening dollar, take a look at the daily chart of the CurrencyShares Euro Trust (FXE), which follows the price of the euro, in relation to the U.S. dollar:
Most apparent on the chart above is the “double top” that FXE recently formed, as marked by the dashed horizontal line. This is a bearish formation that often precedes a significant top. The big question is whether or not FXE will hold support of its 50-day moving average (the teal line), which it barely bounced off of on July 24. Because of the “double top” that preceded this current test of the 50-day MA, odds are now greater that FXE will break down below its 50-day MA in near-term. If a continually strengthening dollar causes that to happen, any bounce in the commodity ETFs could be short-lived. Furthermore, FXE can be sold short if, and only if, it convincingly breaks down below its 50-day MA within the next few days.
If you want to sell short FXE, but your broker has difficulty locating shares for borrowing, even after specifically calling and asking them, an alternative play is to buy the PowerShares U.S. Dollar Fund (UUP). This ETF moves up as the dollar rallies. On the daily chart of UUP below, notice how it has moved above its intermediate-term downtrend line, and is now poised to break out above its 50-day moving average. A breakout above last week’s high, and the 50-day MA, would be our trigger for buy entry:
Note that UUP is composed of an index of various currencies versus the dollar, not just the euro (like FXE). As such, buying UUP is not the same play as simply selling short FXE. To illustrate this in simple terms, look at the following “percentage change chart” that compares UUP and FXE. This is an hourly chart that compares price action of UUP and FXE over the past seven days:
If UUP was tied only to the euro, its gain over the past seven days would have been equal to the loss in FXE over the same period. Instead, notice that UUP has gained 1.5%, compared to a 1.1% loss in FXE. This tells us that, between the two ETFs, buying UUP is a better bet than selling short FXE. If buying UUP on the breakout, realize it has a very low ATR (average true range). As such, share size should be increased accordingly. Subscribers should note our detailed share size, trigger, stop, target prices for the UUP setup below.
As for the broad market, we are neutral on the near-term. The corrective action on July 24 was healthy, and stocks recovered a bit of their gains the following day. However, the major indices, with the exception of the Russell 2000, still remain firmly entrenched in primary, long-term downtrends. The S&P 500 and Dow Jones Industrial Average both fell back below their 20-day EMAs as well. This all means the near-term trends could be choppy and indecisive, which is why we are neutral. As for the intermediate-term, it’s looking more and more likely that the major indices will not be violating their July lows anytime soon. Just don’t forget that we’re still in a bear market. Large, unexpected gap downs are common in such an environment. Overall, odds probably favor the long side of the market right now, but stay alert and cautious until the major indices prove they can move above last week’s highs. Buying with reduced share size on all new positions is a great way to sensibly reduce risk.
PowerShares U.S. Dollar Fund (UUP)
Shares = 1,300
Trigger = 22.69 (above last week’s high and the 50-day MA)
Stop = 22.23 (below the 61.8% Fibonacci retracement from the July 15 low to July 24 high)
Target = 23.88 (just shy of resistance of the February 2008 high)
Dividend Date = n/a
Notes = See commentary and charts above for explanation of the setup. If UUP triggers on the open, note that we will wait until the first three minutes of trading have passed before buying. This is to prevent a singular, rogue trade from falsely triggering the setup. Also, note that our share size is large on this setup because of the low volatility of UUP. Our stop is less than 50 cents from our entry, so our capital risk, even with the increased share size, is the same as always ($600 to $700). Adjust your own share size accordingly. Finally, realize this is an intermediate-term trade. If it triggers, we expect to be in the trade for at least one month.
Separately, we are monitoring the small pullback in S&P Biotech SPDR (XBI). Biotechs continue to act great, so we’re looking for a potential entry in XBI. If we see a low-risk entry opportunity to buy XBI for a short-term trade, we’ll send an Intraday Trade Alert with details of the entry.
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):
- No changes to our EWH position.
EWH long (600 shares from July 22) – bought 16.87, stop 15.89, target 19.30, unrealized points = + 0.15, unrealized P/L = + $90
Closed positions (since last report):
Current equity exposure ($100,000 max. buying power):
Edited by Deron Wagner,
MTG Founder and