The Wagner Daily | August 18, 2008

Commentary:

A choppy, range-bound session last Friday caused stocks to close out the week with little fanfare. Oscillating in a tight, sideways range throughout the entire day, the major indices posted mixed results. Both the S&P 500 and Dow Jones Industrial Average advanced 0.4%, as the Nasdaq Composite slipped 0.1%. The small-cap Russell 2000 and S&P Midcap 400 indices also registered matching declines of 0.1%. Each of the main stock market indexes settled near the middle of its intraday range. For the week, results were also mixed. The tech-heavy Nasdaq Composite climbed 1.6% and the benchmark S&P 500 gained 0.2%, but the blue-chip Dow Jones Industrial Average lost 0.5%.

Total volume in the NYSE rose 17% above the previous day’s level, while volume in the Nasdaq receded 5%. Although the S&P 500 advanced on higher volume, much of the increased trading could have been attributed to last Friday being monthly options expiration day. The indecisive, lackadaisical trading that persisted throughout the day was also not indicative of institutional accumulation. In the NYSE, advancing volume exceeded declining volume by a margin of 3 to 2. The Nasdaq adv/dec volume ratio was roughly flat.

Since forming their intermediate-term bottoms one month ago, the major indices have shown quite a bit of divergence. From their July 15 lows through August 15, the S&P 500 and Dow Jones Industrial Average have risen 6.8% and 6.4% respectively. Gaining 6.3% since its intermediate-term bottom, the S&P Midcap 400 has turned in a similar performance to the large-cap Dow. All three indexes, which have not yet convincingly broken out above their 50-day moving averages, have been the laggards of the bunch. Scoring a much stronger performance has been the Nasdaq Composite, which has rallied 10.8% since its mid-July low. The Nasdaq is also trading firmly above its 50-day moving average, and even its 200-day moving average as well. But even better has been the performance of small-cap stocks.

Last Friday, the Russell 2000 Index, a diverse index of small-cap equities, became the first of the main stock market indexes to test resistance of its June 2008 high. This represented an impressive gain of 14.4% in just over a month, a piece of which we profited from through a recent long position in Ultra Russell 2000 ProShares (UWM). Below is a daily chart of iShares Russell 2000 (IWM), a common ETF proxy for the small-cap Russell 2000 index:

Although the Russell 2000 has clearly been showing the most relative strength of the major indices, it may be difficult for the index to overcome major resistance of its June 2008 high without first undergoing a decent correction. This is because the June 2008 is an anchor point for the long-term downtrend line of the Russell 2000. A confirmed move above the June 2008 high would technically break the downtrend that’s been in place for nearly a year, but that rarely happens on the first attempt.

In the coming week, we’ll be closely monitoring the performance of the Russell 2000. Notice that last Friday’s action saw the Russell probe above its June high on an intraday basis, but the index closed below it. If the Russell 2000 pulls back from here, which is quite likely, the rest of the stock market will probably do the same, simply because the Russell has been the leading index. If, however, the Russell 2000 does not pull back in the near-term, and merely trades sideways to higher instead, it will be a sign that the broad market’s rally of the past month is not yet out of gas. Because the June 2008 high is such a major area of resistance, advanced traders may consider selling short the Russell 2000 (either through shorting IWM or buying the inversely correlated TWM). There is a very nice reward/risk ratio to a short entry at current levels, but just be sure to keep a firm protective stop not far above last Friday’s high.

In addition to the Russell 2000 potentially keeping the market’s gains in check in the coming week, the Nasdaq Composite may do the same. Looking at the weekly chart of the Nasdaq, notice how the index has run into resistance of its weekly downtrend line from its November 2007 high:

Unlike the Nasdaq, both the S&P 500 and Dow Jones Industrial Average have much further to go before running into resistance of their weekly downtrend lines. However, this is not a good thing. Although it may be logical to assume the S&P 500 and Dow Jones will play “catch up” to the relative strength in the Nasdaq and Russell 2000 indices, it’s not likely. A more probable scenario is that a pullback in the Nasdaq and Russell will cause the S&P and Dow to drop harder. Indexes, ETFs, and stocks with relative weakness usually lead to the downside when the broad market pulls back. In last Friday’s Wagner Daily, we illustrated how both the S&P and Dow had yet to even breakout above their 50-day moving averages. They subsequently closed above their 50-day MAs in Friday’s session, but still not by a wide enough margin to declare a confirmed breakout.

As has been the case for the past week, our overall near- and intermediate-term biases remain neutral. Although it’s bullish that the market-leading Russell 2000 has rallied all the way back to its June high, it’s also the most likely point where the index will see a significant correction. The S&P 500 and Dow Jones Industrials are just chopping around near their 50-day MAs and “swing highs” from earlier this month. Our portfolio is biased to the long side, but only with leading healthcare ETFs that are consolidating at their all-time highs. We are also carrying one short position in the financial sector that we just entered last week. Being positioned on both sides of the market is wise when the major indices are at pivotal levels of support or resistance. In tomorrow’s commentary, we’ll take a look at the monthly chart of SPDR Gold Trust (GLD), which has just come into major support of a multi-year uptrend line.

Today’s Watchlist:

With the S&P 500 and Dow Jones Industrials sitting in “no man’s land,” and the Nasdaq Composite and Russell 2000 at key resistance levels, there are no new setups in the pre-market. If the major indices break down firmly below last Friday’s lows, we may enter another short position or two because of the positive reward/risk ratio. If we do, we’ll promptly send an Intraday Trade Alert with details.

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. Please review the Wagner Daily Subscriber Guide for important, automatic rules on trigger and stop prices.

Open positions (coming into today):

unrealized P/L = + $553

SKF long (75 shares from August 15 re-entry) – bought 115.10, stop 111.60, target 144.00, unrealized points = + 3.71, unrealized P/L = + $278

IBB long (200 shares from August 14) – bought 89.10, stop 86.22, target new high (will trail stop), unrealized points = + 0.94, unrealized P/L = + $188

Closed positions (since last report):

net P/L = ($3)

Current equity exposure ($100,000 max. buying power):

$50,873

Notes:

We were a bit too fast to raise our SKF stop to break-even last week, as it corresponded to a stop right at support of the 200-day MA. As such, our initial entry in SKF stopped out last Friday morning. But after realizing the mistake, we immediately re-entered SKF and sent an Intraday Trade Alert informing of such. The first entry stopped out for a scratch, and we got back in near the original entry price, so no damage was done. We normally avoid such fast intraday trade action, but it was necessary in this case.

Click here for a free trial to Morpheus Trading Group’s other newsletter services.

Please check out the Wagner Daily Subscriber Guide to learn how to get the most from your subscription.

Edited by Deron Wagner,
MTG Founder and
Head Trader