What are the consequences of yesterday’s decline?


Commentary:

Averting massive destruction, the major indices bounced back from disastrous intraday losses of approximately 10%, but stocks still finished sharply lower. Both the S&P 500 and Dow Jones Industrial Average swooned 3.2%, while the Nasdaq Composite cratered 3.4%. The small-cap Russell 2000 and S&P Midcap 400 indices shed 3.8% and 3.4% respectively. All the main stock market indexes closed just above the middle of their gargantuan intraday trading ranges, but at the lowest levels of the past two months.

Yesterday’s turnover was tremendous, as volume in both the NYSE and Nasdaq rocketed to its highest levels since 2008. Total volume in the NYSE raced 70% above the previous day’s level. Trading in the Nasdaq similarly leapt 55%. Normally, a higher volume loss, known as a “distribution day,” is a bearish sign of institutional selling into strength. However, one exception is when volume spikes higher on a “down” day, while stocks have already been selling off. Therefore, in this case, yesterday’s monstrous volume that accompanied the huge sell-off could actually be interpreted as a bullish sign of very near-term “capitulation.” Nevertheless, this signal alone does not mean one should run out with reckless abandon and immediately start buying stocks. There could easily be another violent shakeout or two before the broad market finds its footing.

Over the past two weeks, we’ve been warning subscribers about the negative volume patterns that had begun creeping into the broad market, specifically higher volume losses (“distribution”) combined with lighter volume gains. Since we said such patterns of institutional distribution typically precede substantial corrections in the broad market, this week’s decline was not shocking. However, it was admittedly a bit surprising that major support of the January 2010 high of the S&P 500, discussed in yesterday’s commentary, only produced a modest bounce that lasted less than an hour before the index collapsed intraday. Moreover, it was astonishing that the S&P 500 plunged all the way down to “undercut” its 200-day moving average, more than 6% below the 50-day moving average the S&P 500 tested only the previous day.

The popular financial media outlets have been abuzz with speculation regarding the cause of yesterday’s incredible afternoon collapse that briefly caused the Dow to register its second largest intraday decline in history (more than 9%, surpassed only during the 1987 crash). Reports of the culprit have ranged from the erroneous input of a large institutional sell order in the futures markets to computerized trading that led to a lack of liquidity. But although some thick individual stocks (such as PG and ACN) obviously showed evidence of something gone horribly haywire, we believe yesterday’s action was nothing more than a long overdue “shakeout” from the rally off the March 2009 lows, albeit an overly vicious one. Both the NYSE and Nasdaq reported no system malfunctions at any time during yesterday’s session, and computerized “program trading” is nothing new and has been going on for years.

In the April 27 issue of The Wagner Daily, we illustrated how the S&P 500 had rallied to within a few points of its 61.8% Fibonacci retracement level, from its October 2007 high down to its March 2009 low. Specifically, we said, “When markets form a substantial counter-trend bounce, they typically retrace 38.2% to 61.8% of their prior moves before resuming the dominant trend . . . Since the 61.8% Fibo retracement level is considered the “last line of defense” before a trend completely reverses itself, the current pricing area of the S&P 500 is pivotal. If the index manages to convincingly bust through the 61.8% retracement level shown above, odds of the S&P recovering all the way back to its prior highs of 2007 increase substantially. However, IF the market is going to head back down and resume its dominant, long-term downtrend, this is area where it would likely happen.”

Since this month’s correction started as the S&P 500 tested its 61.8% Fibonacci retracement, the market action of the next several weeks to months will likely determine whether or not there is a shift in the long-term trend of the markets. Given yesterday’s action, the rally off the March 2009 lows now finally has a chance to prove its own legitimacy. If, for example, the S&P 500 manages to fully recover and break out to a new 52-week high, one could probably declare the multi-year bear market is finally dead. However, until that happens, traders and investors should be prepared for several more scary “shakeout” attempts along the way.

Whatever actually caused yesterday’s intraday meltdown is not our concern. What really matters is there are no clear ETF trade setups on either side of the market right now. At the least, we need to let the market settle down for a few days before determining which side of the market yields the best odds of profitability. Some buying opportunities may soon arise, but right now there is too much technical damage on the charts to have any clear indication. Given the results of yesterday’s session, we were thrilled to have been positioned 100% in cash going into the day. Because we heeded the warning of the volatile price action and institutional distribution that preceded the plunge, our full cash position enabled us to preserve all the hard-earned profits of the first four months of the year. Patience and discipline in the current environment remains of paramount importance.


Today’s Watchlist:

There are no new setups in the pre-market today. However, we will promptly send an Intraday Trade Alert if we enter any ETF positions today.


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.

    position summary

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    Notes:

  • We are currently “flat and happy,” waiting in capital preservation mode.
  • 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 [email protected] if not already set up for this value-added feature we provide to subscribers.
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      Edited by Deron Wagner,
      MTG Founder and Head Trader