Commentary:

With textbook precision, the 50-day moving averages of the major indices “did their thing” yesterday, sparking a solid rally off that closely-watched level of support. After a brief wave of selling in the first hour of trading, stocks reversed to trend higher throughout the rest of the session. The benchmark S&P 500 Index gained 1.5% and the Dow Jones Industrial Average advanced 1.2%. The Nasdaq Composite, which showed slight relative weakness by drifting sideways throughout much of the day, closed 1.0% higher. The small-cap Russell 2000 and S&P Midcap 400 indices climbed 1.9% and 2.1% respectively. The major indices settled off their best levels of the day, but still closed near the upper quarter of their intraday ranges.

While the broad market’s bounce off the 50-day moving averages was substantial, lighter volume lessened the power of the punch. Total volume in the NYSE declined 22%, while volume in the Nasdaq was 12% lighter than the previous day’s level. In both exchanges, turnover also slipped back below average levels. Considering both the S&P and Nasdaq have suffered four days of higher volume losses (“distribution days”) in recent weeks, increasing volume on yesterday’s bounce would have made the rally more convincing. Instead, mutual funds, hedge funds, and other institutions were apparently limiting their buying operations yesterday. Nevertheless, market internals were firmly positive, indicating the buying was broad-based. In the NYSE, advancing volume exceeded declining volume by a strong margin of nearly 9 to 1. The Nasdaq adv/dec volume ratio was positive by 4 to 1.

Precious metals heated up yesterday, enabling SPDR Gold Trust (GLD) to close just pennies below the high of its tight, four-week consolidation. If bullish momentum from yesterday’s session follows through, GLD will break out above the high of its recent range, and also move into the territory of a fresh all-time high. Although GLD has a rather extensive history of failing its breakout attempts, one thing we really like about the current price action is how well GLD has been behaving in recent weeks. The consolidation has been tightening up, and last week’s pullback to its 20-day exponential moving average was short-lived. Below is a weekly chart of GLD:

As GLD gained 1.4% yesterday, its sibling, iShares Silver Trust (SLV), zoomed 3.5% higher. Over the longer-term, SLV has shown relative weakness to GLD because it is still well below its all-time high from March of 2008. However, the shorter-term pattern of SLV may be conducive for a nice swing trade over the next week. Check out our annotated daily chart of SLV below:

In the September 28 issue of The Wagner Daily, we pointed out a potential momentum trade that was setting up in iShares 20+ Year Treasury Bond Fund (TLT). At the time, TLT was breaking out above a significant area of horizontal price resistance, and we said it could be bought for a quick momentum trade. If buying it, we specifically said, “TLT could be sold into strength, as it tests its 200-day MA (around $100.40).” Following through on bullish momentum from the breakout, TLT rallied to the area of our target price ($100.31) on October 2 (five days later). Our intended time frame on the trade was short because resistance of the 200-day moving average could be difficult to overcome in the near-term. On the chart below, notice how TLT probed above its 200-day MA on October 2, running stops, then pulled back below that level. We did not “officially” take the TLT trade because we focus on trades with a slightly longer holding period. However, we originally pointed it out for those who like the quicker, shorter-term trades:

In addition to GLD and SLV, another commodity ETF positioned for a high-momentum, near-term rally is U.S. Natural Gas (UNG), which we’ve been long since late September. Yesterday, UNG closed right at the high of its multi-week consolidation, after neatly “undercutting” support of its 20-day exponential moving average (EMA) last week. This puts UNG squarely above its 50-day moving average for the first time in months. If it holds, the intermediate-term bias of UNG will become bullish. Until now, only the short-term trend has been “up.”

On the chart of UNG above, we’ve circled last week’s “undercut” of the 20-day EMA. For educational purposes, let’s talk about the “undercut,” as it is a classic pattern that’s good to watch out for.

When chart patterns are too “obvious,” such as the potential breakout in UNG, big money funds will often move the price in the opposite direction of everyone’s expectations, causing traders’ stop losses to be hit. Meanwhile, the “smart money” scoops up shares at a lower price. Then, one to two days later, the price quickly jumps back into the previous range, as if the preceding break of support never even happened. Rather than being negative, an “undercut” is actually a positive event, as it has the effect of shaking out the “weak hands” who set their stop prices too tightly below the obvious level of support. This subsequently has a bullish effect on the price because overhead supply becomes absorbed, making it easier for the stock or ETF to move higher thereafter. But in order for “undercuts” to be valid, there are a couple things to know:

• The “undercut” should not be more than 3 to 4% below the obvious level of support. On the day UNG broke down below its 20-day EMA, the intraday low was equal to 3.5% below the 20-day EMA. If UNG had fallen more than 5%, for example, we would have been more inclined to label the sell-off as a legitimate break of support, rather than a bullish “undercut.”
• An “undercut” should immediately snap back the following day, at least to the previous day’s high. If it doesn’t, one must wonder what happened to the buying interest that was supposed to follow the shakeout. The day after it broke support, UNG indeed raced back to the previous day’s high, then gapped back into the range on October 6.
• Don’t be afraid to re-enter the position if the “undercut” stopped you out of the trade. In the past, we’ve occasionally made the mistake of having our stop just a bit too tight, therefore causing us to be snagged by the “undercut.” No matter how much thought is put into stop placement, you’re simply going to get snookered every now and then. Yet, this isn’t a problem, just as long as you re-enter the trade upon confirmation of the following day’s reversal back into the range (using a tight stop as well). Granted, you’ll probably be buying back into the trade at a slightly higher price than where you sold, but it doesn’t matter! If the breakout takes off, you may gain 5 points on the trade, rather than 6. But if you don’t re-enter the trade at all, you’ll make 0 points instead of 5. Not a tough decision.

As for the broad market, keep a close eye on the October 2 lows of the major indices. Since those lows converge with support of the 50-day moving averages, it’s critical that the main stock market indexes do not close below their October 2 lows in the coming days. If they do, the broad market will likely have entered into an intermediate-term correction, one that becomes more substantial than other pullbacks in recent months. Conversely, the short-term trends are still down, but another day of gains to push stocks above new resistance of their 20-day EMAs could significantly improve the near-term outlook. For now, we continue to focus mostly on ETFs with a low correlation to the direction of the broad market.

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Today’s Watchlist:

There are no new setups in the pre-market today. If any new trades are entered, we’ll promptly send an Intraday Trade Alert with details.

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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.

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Notes:

• After a somewhat slow start, our diverse mix of positions with low overall market correlation is starting to look pretty good now. All but one of the six open positions is now showing an unrealized gain.
• Per Intraday Trade Alert, we bought another 100 shares of DGP yesterday. The new position size and average price is shown above. No changes to the stop, which still locks in a solid profit in the event of a failed breakout.
• We have raised the stop in FCG, as a retracement below yesterday’s low would not be good for the position. The tighter stop cuts our initial capital risk in half.

• 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