Commentary:

Resolving the previous day’s indecision, stocks made a decisive, downward move that resulted in sizeable losses across the board yesterday. Unlike the choppy price action of recent days, a steady, intraday trend (down) persisted from the open to the close. The Dow Jones Industrial Average tumbled 1.2%, the S&P 500 2.0%, and the Nasdaq Composite 2.7%. The small-cap Russell 2000 and S&P Midcap 400 indices plunged 3.6% and 3.3% respectively. Each of the major indices closed at its worst level of the day.

Volume surged across the board, as institutional money rushed for the exit doors. Total volume in the NYSE jumped 20%, while turnover in the Nasdaq similarly rose 17% above the previous day’s level. Over the past month, we’ve been warning about the stock market’s bearish price to volume relationship, including a slew of “distribution days” (higher volume losses), and the substantial selling we’re now seeing is the outcome of that early warning signal. However, now that the stock market has entered into correction mode, keeping track of the number of “distribution days” is not important. Rather, we will now be on the lookout for signs of institutional accumulation (higher volume gains) that always precede a significant market bottom.

While mutual funds, hedge funds, and pension funds may base their primary investment decisions on fundamental analysis, rather than technical analysis, one technical indicator commonly followed by most institutions is the 50-day MA. As long as the main stock market indexes are trending above their 50-day MA, the intermediate-term trend is considered to favor the bulls. Conversely, the environment is often more favorable to the bears when the major indices are trending below their 50-day MAs. In sideways, range-bound markets, the 50-day MA has less significance because the indexes will frequently cross back and forth through the 50-day line. Yesterday, all the main stock market indexes except the Dow closed below key support of their 50-day moving averages (50-day MA). It was the first time the major indices have breached that pivotal indicator of intermediate-term trends since early July of this year. The breach of the 50-day MA can be seen on the daily chart of the S&P 500 below:

On October 2, the S&P 500 (as well as the other indexes) pulled back to kiss support of its 50-day MA, then bounced neatly off of it the following day. But yesterday, the index actually closed below its 50-day MA (by 0.8%). As the chart above illustrates, the last time this happened was back in late June/early July. From July 2 to 14, the S&P 500 traded below its 50-day MA, causing some traders to believe the uptrend that began four months prior may have been finished. However, more significant, longer-term support of the 200-day MA (the orange line) caught the price of the S&P, enabling the index to rally back above its 50-day MA and stage another massive run.

This time, the 200-day MA is much further below the current price of the S&P 500 (12% to be exact), so it’s not likely to be a positive technical factor to the market anytime soon. Instead, one should keep a close eye on the important “swing low” support level from October 2 (marked by the dashed, horizontal line on the chart above). While stocks have already entered into a near-termdowntrend, the intermediate-term uptrend is technically still intact unless the October 2 low is violated (by at least 2 to 3%). Such action would cause a legitimate “lower low” to form, which would subsequently increase the odds of a much deeper correction off the March 2009 lows. The 200-day MA would not be an unrealistic, downside price target if the October 2 low fails to hold.

Looking at the market internals, yesterday’s selling was rather extreme. In both the NYSE and Nasdaq, declining volume beat advancing volume by a margin of more than 9 to 1. When such an overly bearish adv/dec volume ratio occurs after a string of losing sessions, it often precedes at least a modest one or two-day bounce in the markets. Therefore, odds are pretty decent that we see a little buying interest today or tomorrow, especially considering many traders will be speculating on the possibility of the major indices snapping back above their 50-day MAs. Nevertheless, we caution against blindly entering new swing trades on the long side of the market right now. In order to do so, we would first want to see some type of bullish confirmation, such as a day or two of high volume gains and/or sudden strength among leading stocks.

This newsletter’s model ETF portfolio is now down to just three positions. We quickly closed our losing trade in U.S. Natural Gas Fund (UNG) yesterday, when it failed to hold support of its two-day low. However, our position in Financial Bear 3X (FAZ) rocketed 8.7% higher yesterday. Our other two positions, U.S. Oil Fund (USO) and UltraShort 20+ year T-bond (TBT), declined moderately yesterday, but both have come into support of their 20-day exponential moving averages. Fortunately, heeding the warning signals of the market’s bearish price to volume relationship over the past month, resistance of the two-year downtrend lines in the S&P and Dow, and relative weakness in the Russell 2000 enabled us to stay largely out of harm’s way during the decline of the past week. The FAZ position we recently entered helped hedge the few long positions we were carrying, and being in “SOH mode” (sitting on hands) prevented us from overtrading on the way down.

Over the next couple days, we’ll be focusing on observing the market’s signals, rather than worrying about entering new positions at current levels. If stocks stabilize and legitimate bullish signs present themselves, we will cautiously look to buy ETFs that showed the most relative strength during the market’s pullback. On the other hand, a feeble bounce that appears to have no legs may present new opportunities to initiate another short position or two, into resistance of the support levels that have recently been broken. As always, we’ll keep you informed with what is technically happening in the markets, and will be sure to trade what we see, not what we think.

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Today’s Watchlist:

If USO trades through the 40.31 level, we will add an additional 50 shares to the position. This would give us a total position size of 200 shares, at which point we would update the stop in tomorrow’s newsletter. Other than the additional shares of USO, there are no new “official” trades in today’s commentary.

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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:

• UNG stopped out yesterday morning.
• Stop has been tightened in FAZ, and we’ll continue to trail it higher as we’re able.

• 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.
• 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.

Edited by Deron Wagner,
MTG Founder and
Head Trader