Commentary:

After spending the holiday-shortened week in a lazy, narrow, sideways range, the main stock market indexes sold off sharply in the final thirty minutes of the last trading session of 2009. Last Thursday, both the S&P 500 and Nasdaq Composite fell 1.0%. The Dow Jones Industrial Average slid 1.1%. The small-cap Russell 2000 and S&P Midcap 400 indices registered identical losses of 1.3%. All the major indices closed at their intraday lows, as well as their lows of the week. However, stocks still managed to log another round of gains in December. For the month, the Nasdaq showed clear relative strength with its 5.8% gain. The S&P and Dow advanced 1.8% and 0.8% respectively.

Total volume in the Nasdaq was 4% lighter than the previous day’s level, but volume in the NYSE rose 5%. The loss on higher volume technically caused the S&P 500 to register a bearish “distribution day.” However, with turnover remaining well below average levels, last Thursday’s session was not exactly driven by heavy institutional selling. The week between Christmas and New Year’s Day is typically the slowest week of the year. As such, one cannot read too much into the price action. After several weeks of light, holiday volume levels, traders can now look forward to the gradual return of market activity amongst mutual funds, hedge funds, pension funds, and other institutions in the coming days. Regardless of whether the start of 2010 is a short-term continuation of last week’s pullback, or a resumption of the dominant uptrend, the increased volume levels should provide a better-trending market.

On December 24, the S&P 500 broke out above the high of a seven-week base of consolidation. However, since it did so on minimal volume, it didn’t take a lot of selling pressure to cause the index to drift right back down. Last week’s retracement, most of which occurred in the span of just thirty minutes, now positions the benchmark S&P 500 to kick off 2010 right at support of its recent breakout level. Below, this is shown on the daily chart of the S&P:

One of the most basic tenets of technical analysis is that a prior level of resistance becomes the new support level after the resistance is broken. As such, the S&P 500 should find significant support on this pullback to the high of its prior consolidation. Support of the 20-day exponential moving average (the beige line) provides further technical support. Still, it may be prudent to use caution in the coming days, as the S&P 500’s recent breakout above the seven-week band of consolidation occurred on minimal volume, and therefore without the backing of institutional accumulation. As we’ve recently discussed, and as last Thursday’s late-day sell-off demonstrated, gains that occur on decreasing volume can be easily undone by just one session of higher volume selling. Furthermore, remember the S&P 500 is also coming into major resistance of its long-term downtrend line that began with the October 2007 highs (as per this commentary and analysis from last week).

Going into the new year, our model ETF portfolio is lightly positioned with just one long and one short position (SMH and FAZ, respectively). But as volume begins returning to the markets, we’ll be looking to enter new positions. Below are charts of two ETFs we are monitoring for potential buy entry in the coming days. The first is the S&P Select Energy SPDR (XLE):

On December 23, XLE broke out above resistance of a two-month downtrend line, as well as its 50-day moving average (the teal line). It moved slightly higher in the days that followed, then pulled back last week to close right at convergence of its prior downtrend line, 20-day EMA, and 50-day MA. The more levels that converge at a certain point, the greater the support should be. Therefore, a pullback entry into XLE near its current price level may be ideal. We’re stalking XLE for possible buy entry above its 20-period EMA on the hourly chart (around $57.50). Regular subscribers should note our detailed trigger, stop, and target prices on “Today’s Watchlist” below.

An international ETF we’re monitoring for possible breakout entry is iShares South Korea Index (EWY). The setup is illustrated and explained on the daily chart below:

In addition to XLE and EWY, there are a handful of other ETFs we like for potential buy entry in the near-term. We’ll analyze more of those charts as the week progresses. Nevertheless, we don’t think it’s wise to aggressively start entering a plethora of new long positions within the next several days unless we see the swift return of institutional buying to support the recent breakout in the broad market. The short to intermediate-term trends remain “up,” but we’ll have a much better indication of the market’s next, immediate move after volume starts coming back into the markets. We plan to ease back into managing and building an updated portfolio, just as most institutions will probably be doing at the start of the new year.

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Today’s Watchlist:

S&P Select Energy SPDR (XLE)
Long

Shares = 200
Trigger = 57.58 (above the 20-EMA on the hourly chart)
Stop = 55.49 (below the 61.8% Fibonacci retracement from the December low to high)
Target = new 52-week high (will trail stop)
Dividend Date = March 2010

Notes = See commentary above for explanation of the setup. Also, traders with small accounts might alternatively consider trading the leveraged Energy Bull 3x Shares (ERX), which has a similar chart pattern to XLE. However, the “official” trade will be into XLE (if it triggers).

In addition to XLE, we’re stalking EWY for possible buy entry as well. However, because international ETFs frequently have large opening “gaps,” we prefer to assess opening and intraday price action, rather than listing it as an “official” trade in the pre-market. If EWY moves above last Thursday’s high and we decide to buy, 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:

• EEV hit our stop by just a penny last Thursday. We remain long FAZ and SMH.
  
  
• 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