Bearish momentum from the May 6 plunge caused stocks to suffer another round of broad-based losses last Friday, though the major indices held well above their intraday lows of the previous day. The main stock market indexes promptly slid lower in the first hour of trading, attempted to recover into mid-day, then drifted back down in the afternoon. The Dow Jones Industrial Average declined 1.3%, the S&P 500 1.5%, and the Nasdaq Composite 2.3%. Small and mid-caps led the way lower again, as the Russell 2000 tumbled 2.9% and the S&P Midcap 400 swooned 2.6%. Despite substantial losses, the broad-based indices still finished above the lower third of their intraday ranges. The Nasdaq, for example, was off nearly 4% at its low of the day, so at least there was a bit of stability into last Friday’s close.
Total volume in the NYSE was 6% lighter than the previous day’s level, while volume in the Nasdaq ticked 9% lower. Nevertheless, turnover in both exchanges remained near its highest levels of the past year. Market internals remained rather ugly. In the Nasdaq, declining volume trounced advancing volume by a margin of 10 to 1. The NYSE adv/dec volume ratio was negative by nearly 6 to 1.
As we enter the new week, the broad market remains under distribution. Leading stocks again fell apart last Friday, causing more technical damage on charts of what were formerly the best performers in the market. The good news is the major indices could start forming new bases of support in the coming weeks, enabling fresh leadership to develop when the broad market eventually starts heading back up. But until that happens, the short-term trend of the overall market is negative. This means the reward/risk ratio for new trade setups probably favors the short side of the market. Specifically, we’re now looking for near-term short sale entries on ETFs that sliced through key levels of support last week, then bounce into new resistance of those prior support levels this week. Here are a few charts we’re monitoring for potential short entry on a bounce:
With just about every ETF getting whacked last week, there are many more charts worthy of selling short on a bounce as well. However, we feel the three ETFs above each provide a rather positive reward/risk ratio, have a convergence of several overhead resistance levels, and a large amount of overhead price supply. Traders with non-marginable cash accounts, such as an IRA, may alternatively consider buying the inversely correlated “short ETFs” that track the sectors above. Rather than selling short a bounce into resistance, one would simply buy the pullback to support instead. For small-caps (IWM), consider TWM or TZA. For basic materials (IYM), SMN is a suitable inverse ETF. For securities broker-dealers, we’re not aware of an inverse ETF that specifically targets that financial sub-sector. However, two inverse ETFs that track the broader financial sector are SKF and FAZ. As with all inverse and leveraged ETFs, remember there is generally an underperformance to the associated index with longer holding periods. Therefore, any inverse ETFs should be entered with a short-term time horizon.
Over the weekend, European policy makers announced a loan package worth almost $1 trillion, as well as a program of bond purchases, to attempt to stop a sovereign-debt crisis that has been hammering the euro. In overseas trading, the move was well received, as European and Asian shares were last seen trading sharply higher. Not surprisingly, the positive reaction has carried over to the U.S. futures markets as well. As of the early pre-market session, both the S&P and Nasdaq futures are poised to open more than 4% higher. If they do, the major indices may open just below the level that started the May 6 intraday collapse. Although this is encouraging, the big question is whether or not traders and investors who got stuck in last week’s sell-off, and are now sitting on losing positions, will immediately sell into strength of the opening bounce. With a ton of overhead supply near the recent highs, we believe there’s a good chance they will.
We view today’s sharp opening gap as an opportunity to do two things: 1.) unload or lighten up on losing long positions that, for whatever reason, were not sold last week 2.) Lightly initiate new short positions on ETFs that broke down last week, and are opening at or near major resistance levels. Obviously, the possibility exists that stocks will move back to their prior highs without any further selling. However, there is a greater chance the technical damage created from last week’s collapse will take more than a few days to heal. A more likely scenario than stocks immediately racing back to last week’s highs is that we first see another violent shakeout or two, followed by several weeks of constructive price consolidation, which could eventually lead to a new uptrend. Therefore, while we think the opening gap could provide a few ideal short entry points with positive reward/risk ratios, we only plan to enter one or two new short positions, each with a near-term time horizon. Thereafter, we’ll be looking for new buying opportunities as fresh bases of support establish themselves. The nice thing is that, because we were all cash throughout last week, and coming into today, we fully preserved capital during the whipsaw action of the past few days. Below, regular subscribers should note our detailed trigger, stop, and target prices for two new ETF short entries in today’s session.
| Open ETF positions:
Long – (none) |
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Deron Wagner is the Founder and Head Portfolio Manager of Morpheus Trading Group, a capital management and trader education firm launched in 2001. Wagner is the author of the best-selling book, Trading ETFs: Gaining An Edge With Technical Analysis (Bloomberg Press, August 2008), and also appears in the popular DVD video, Sector Trading Strategies (Marketplace Books, June 2002). He is also co-author of both The Long-Term Day Trader (Career Press, April 2000) and The After-Hours Trader (McGraw Hill, August 2000). Past television appearances include CNBC, ABC, and Yahoo! FinanceVision. Wagner is a frequent guest speaker at various trading and financial conferences around the world, and can be reached by sending e-mail to deron@morpheustrading.com.
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