Commentary:

Opening above the highs of their recent consolidation patterns, stocks broke out above their short-term trading ranges yesterday morning, but a late-day reversal caused the major indices to surrender a majority of their intraday gains. The S&P 500 gained 1.2% and the Dow Jones Industrial Average climbed 0.9%. The Nasdaq Composite finished 0.8% higher, though the index was trading 2.1% higher at its best level of the day. Small and mid-cap stocks turned in the best performance. The Russell 2000 climbed 1.7%, as the S&P Midcap 400 Index advanced 1.3%. The S&P 500 and Dow Jones Industrials closed near the middle of their intraday ranges. For the first time in weeks, the Nasdaq settled near the day’s low.

Turnover surged 19% across the board, technically causing the S&P 500 and Nasdaq Composite to register a bullish “accumulation day” by gaining on higher volume. But given the late-day selling and weak closing prices of the major indices, mutual funds, hedge funds, and other institutions were apparently selling into strength as well. Turnover in both exchanges moved back above average levels, which wasn’t surprising considering many traders and investors were waiting on the sidelines until the market made a move out of its preceding range. Market internals started the day quite positive, but deteriorated as the day progressed. By the closing bell, advancing volume exceeded declining volume, in both exchanges, by approximately 2 to 1.

We enter the last day of a very bullish month with the stock market at a rather interesting juncture. Coming into this week, many traders (including us) were looking for the major indices to pull back slightly, which would have provided a multitude of buying opportunities in strongly trending ETFs. Instead, stocks entered into a “correction by time,” consolidating in a tight, sideways range near the highs. Then, yesterday, the broad market gapped above the highs of its recent consolidation, on higher than average volume. Initially, this appeared to be a bullish continuation of the dominant uptrend, but institutions sold into strength of the move, causing the main stock market indexes to close near their intraday lows and form bearish “shooting star” candlestick patterns on their daily charts. This puts the major indices in danger of failing yesterday’s breakout attempt. We’ve highlighted the “shooting star” pattern on the daily chart of the Dow Jones DIAMONDS (DIA), a popular ETF proxy for the Dow Jones Industrial Average:

Over the past few days, we’ve been saying the market has been “a bit confused and nervous.” As such, yesterday’s strength on the open, followed by weakness in the afternoon, was not very shocking to us. It was merely the reverse of the intraday price pattern we’ve been seeing, where stocks have started the day showing weakness, only to recover into the close. Still, one key difference between yesterday’s intraday trend reversal, and other intraday reversals of the past week, is that yesterday’s tug-of-war between the bulls and bears occurred as the major indices should have been showing strength after the opening breakout. On a technical level, the breakout had no significant overhead resistance levels to contend with, but it fizzled out regardless.

In yesterday’s Wagner Daily, we discussed the increasing possibility of the major indices breaking out above the highs of their recent trading ranges, without pulling back first. If that happened, we said we would “go with the flow” and selectively enter a few new long positions. However, we also cautioned that, “the only caveat is that any new entries we take will have tight stops, just below their breakout levels. This will help to protect against the possibility of ‘fakeout breakouts.’ When buying a breakout above a tight base of consolidation, we’ve found that tight stops are most effective in protecting against the vicious downside momentum that frequently occurs from failed breakouts.” When stocks gapped up yesterday morning, we followed our plan and entered two new long positions (TAN and INP), but subsequent weakness in the broad market prompted us to make a judgment call to sell our positions for a scratch, rather than risking getting long just as the broad market potentially fails a breakout attempt. The problem with breakouts above obvious levels of resistance in the major indices is they have a high rate of failure; institutions frequently use the liquidity boost of the breakout as a chance to sell into strength.

Yesterday’s price action leaves us with a situation where many ETFs have just broken out above resistance levels, but are now in immediate danger of failing their breakouts. Such action could lead to a substantial downside correction if those ETFs quickly fall back into the previous ranges they just broke out above. Nevertheless, unless the major indices fall below the lows of their recent trading ranges, quite a bit below current levels, short positions are not very attractive. Conversely, new long entries after yesterday’s weak close could be dangerous as well. Therefore, our current overall plan consists of two low-risk strategies:

The first strategy is to focus new ETF entries with a low correlation to the direction of the overall stock market. This would include various currency or commodity-based ETFs, of which we’re already positioned in one of each. The second strategy is to build and maintain a watchlist of strong ETFs to buy if they retrace to key support levels such as their 20 or 50-day moving averages.
Below are two charts of ETFs with low correlation that may be buyable in the near-term:

We began discussing FXB as a potential buy entry last week, but it apparently was not yet ready to go. However, with the 10-week moving average rising up to provide support, and the trading range tightening up over the past two weeks, FXB now looks even more attractive for breaking out of its base. We like it for buy entry above the $166.50 area. Next, take a look at the daily chart of U.S. Oil Fund (USO), which is roughly correlated to the price of the crude oil commodity futures:

Because of its close proximity to pivotal moving averages, such as the 20, 50, and 200-day moving averages, USO has been very choppy and indecisive over the past week. Yet, if USO rallies above the July 27 high of $36.48, bullish momentum could send USO substantially higher, above the June 2009 high, in the short-term. This is primarily because it would lead to a breakout above the 200-day moving average for the first time in nearly a year. Convergence of the 20, 50, and 200-day moving averages, just below that breakout level, would provide solid support in the event of a subsequent pullback.

As for a watchlist of ETFs to buy on a pullback, there are now quite a few that look appealing. Numerous international ETFs have been showing relative strength to the domestic markets, and would be attractive on a pullback to their breakout levels and/or 20-day moving averages. As for industry sectors within the U.S. markets, biotech and semiconductor ETFs have been showing the most strength. Below is a list of a few ETFs we are monitoring, as well as approximate “buy zones” to consider. With all of these, it’s crucial to patiently wait for a pullback, rather than jumping in at current prices:

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Today’s Watchlist:

There are no new setups in the pre-market today. Because of yesterday’s indecisive price action at a critical juncture, it’s best to let the market settle down and figure out which way it wants to go from here. As always, we’ll promptly send an Intraday Trade Alert if we enter anything new.

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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.

PLEASE NOTE: As of July 1, we have updated to a more “user friendly” format for reporting open and closed positions (see below). Based on the familiar Microsoft Excel style, we believe the new, simplified format makes it much easier to see the status of all positions with just a quick glance. What do you think? We’d love to hear your opinion on the new format change. Just send an e-mail to editors@morpheustrading.com.

Notes:

• Both of yesterday’s setups, INP and TAN, triggered for long entry after the open. However, late in the day, we made a judgment call to sell these positions for a scratch (gain or loss of less than $100). Due to weak broad market action and a bearish pattern on the day of entry, we saw no point in taking the overnight risk of a failed breakout. Nevertheless, we’ll keep these ETFs on our radar screen for potential re-entry if they hold up.

• For those of you whose ISPs occasionally deliver your e-mail with a delay, make sure you’re signed up to receive our free text message alerts sent to your mobile phone. This provides a great way to have redundancy on all Intraday Trade Alerts. Send your request to support@morpheustrading.com if not already set up for this value-added feature we provide to subscribers.
• Reminder to subscribers – Intraday Trade Alerts to your e-mail and/or mobile phone are normally only sent to indicate a CHANGE to the pre-market plan that is detailed in each morning’s Wagner Daily. We sometimes send a courtesy alert just to confirm action that was already detailed in the pre-market newsletter, but this is not always the case. If no alert is received to the contrary, one should always assume we’re honoring all stops and trigger prices listed in each morning’s Wagner Daily. But whenever CHANGES to the pre-market stops or trigger prices are necessary, alerts are sent on an AS-NEEDED basis. Just a reminder of the purpose of Intraday Trade Alerts.

Edited by Deron Wagner,
MTG Founder and
Head Trader