Stocks concluded the holiday-shortened week with a third consecutive plunge last Friday, causing the major indices to firmly slice through support of their 50-day moving averages. The broad market traded sideways to lower throughout the morning session, but the bears returned with conviction in the afternoon. The Dow Jones Industrial Average nosedived 2.1%, the S&P 500 2.2%, and the Nasdaq Composite 2.7%. Small-caps showed slight relative strength, as the Russell 2000 fell 1.8%. The S&P Midcap 400 lost 2.1%. All the main stock market indexes finished at their worst levels of the day and week.
Total volume in the NYSE was 1% lighter than the previous day’s level, while volume in the Nasdaq eased 3%. The slightly lower turnover prevented the S&P and Nasdaq from registering a another bearish “distribution day.” However, with a slew of higher volume losses already accumulated, and the major indices now firmly below their 50-day moving averages, it’s safe to say stocks have already entered into correction mode. As such, we’re now monitoring for the occurrence of higher volume gains, rather than continuing to count the sessions of higher volume losses. If this correction is to play out like other pullbacks since the current uptrend began last March, we should soon see the return of institutional accumulation. But until that happens, it’s prudent to avoid new buy entries into ETFs with a high correlation to the direction of the broad market. Furthermore, it’s crucial to closely monitor and honor protective stops on any existing long positions.
One concerning attribute of last week’s sell-off is that even the industries with relative strength sustained technically damaging losses. Conversely, all the other corrections of the past ten months were marked by the rotation of institutional funds from one sector to another. Before the plunge of the past three days began, the energy ETFs were showing relative strength by consolidating near their recent highs. Now, however, those bullish patterns have been damaged. Similarly, many financial ETFs were forming “cup and handle” patterns in the beginning of last week, but those bullish patterns are now violated. To illustrate this, take a look at the S&P Energy SPDR (XLE) and S&P Financial SPDR (XLF), two ETFs we were previously stalking for potential buy entry:
Fortunately, neither of these ETFs, or related ETFs, triggered our buy entry levels last week, so no harm was done. Nevertheless, the negative price action of these sectors, combined with broad-based selling in practically every other industry, hints that this correction may become a bit more protracted than others that have rebounded within just one to two weeks. Again, the key is to monitor for the return of institutional accumulation, as measured by the presence of higher volume gains. Without it, the possibility of a lengthier correction will be confirmed.
Last Friday’s weakness caused the iPath Platinum ETN (PGM) to gap down well below support of its 20 and 50-day moving averages, thereby causing us to close the trade for a loss. However, our position in the inversely correlated UltraShort Emerging Markets ProShares (EEV) zoomed 4.3% higher. As our only bearish position, we bought EEV on January 15, when emerging markets started to show significant relative weakness. Since that entry just five days ago, EEV has cruised 11.9% higher. It has also convincingly closed above its 50-day moving average for the first time since the broad market rally began in March of 2009. Over the next few days, we now expect a bit of price consolidation, perhaps the formation of a “bull flag,” before EEV rallies to make another leg higher. Assuming the broad market correction persists for more than a few days, resistance of the late October/early November highs is a realistic, intermediate-term target for EEV. Take a look:
With the major indices already in confirmed, near-term downtrends, we’re now starting to monitor more of the inversely correlated “short” ETFs for potential buy entry. But after three straight days of massive losses in the broad market, the reward-risk ratio of entering new bearish positions at current levels is not very positive. Rather, we are now waiting for the stock market to bounce into recently created resistance levels, then start rolling back over again. At that time, we would consider buying the inversely correlated ETFs with the most relative strength and bullish chart patterns (such as EEV above). Still, we will only consider new short entries if the volume patterns remain negative (ie. rallying on lighter volume).
Although we’re advocating the avoidance of new long entries into ETFs with a direct correlation to the stock market’s direction, currency, commodity, and fixed-income ETFs may provide opportunities that are more immune to sharp movements in the major indices. Aside from the possibility of “short” ETFs, these three areas may be the best place to focus current buying operations. Within that realm, we continue to like the developing pattern in U.S. Natural Gas Fund (UNG), which is forming a tight band of consolidation above its 50-day MA:
Stuck in a steady downtrend throughout the entire year, UNG was one of the worst-performing ETFs of 2009. However, it looks as though UNG has finally bottomed, and is poised to reverse its dominant downtrend. For starters, we like that UNG “undercut” support of its September 2009 low early last month. This had the effect of shaking out the last of the die-hard bulls, who will soon be forced to re-enter UNG when it starts to move higher. Furthermore, prior resistance of the 50-day MA is now acting as the new support level. If UNG moves above the $10.50 level, it will trigger our buy entry, in anticipation of resumption of the bullish reversal that began last month. Alternatively, traders may consider waiting for UNG to rally above the $11 level before buying, but we believe a breakout above the high of its short-term consolidation will quickly propel UNG above the $11 area as well. Even if it doesn’t, we can simply scratch the trade and re-assess the setup.
U.S. Natural Gas Fund (UNG)
Shares = 400
Trigger = 10.55 (above the Jan. 14 high)
Stop = 9.25 (below the 61.8% Fibonacci retracement off the lows)
Target = 13.20 (area of prior price congestion)
Dividend Date = n/a
Notes = This setup from last week did not yet trigger, but remains on our watchlist going into today. See commentary above for explanation of the setup.
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.
- PGM gapped down below our stop, prompting the use of the MTG Opening Gap Rules. Thereafter, PGM briefly broke below its 20-minute low, causing us to close the trade. Since the breakout in PGM has failed, we no longer want to be long.
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Edited by Deron Wagner,
MTG Founder and Head Trader