With textbook precision, the 50-day moving averages of the major indices “did their thing” yesterday, sparking a solid rally off that closely-watched level of support. After a brief wave of selling in the first hour of trading, stocks reversed to trend higher throughout the rest of the session. The benchmark S&P 500 Index gained 1.5% and the Dow Jones Industrial Average advanced 1.2%. The Nasdaq Composite, which showed slight relative weakness by drifting sideways throughout much of the day, closed 1.0% higher. The small-cap Russell 2000 and S&P Midcap 400 indices climbed 1.9% and 2.1% respectively. The major indices settled off their best levels of the day, but still closed near the upper quarter of their intraday ranges.
While the broad market’s bounce off the 50-day moving averages was substantial, lighter volume lessened the power of the punch. Total volume in the NYSE declined 22%, while volume in the Nasdaq was 12% lighter than the previous day’s level. In both exchanges, turnover also slipped back below average levels. Considering both the S&P and Nasdaq have suffered four days of higher volume losses (“distribution days”) in recent weeks, increasing volume on yesterday’s bounce would have made the rally more convincing. Instead, mutual funds, hedge funds, and other institutions were apparently limiting their buying operations yesterday. Nevertheless, market internals were firmly positive, indicating the buying was broad-based. In the NYSE, advancing volume exceeded declining volume by a strong margin of nearly 9 to 1. The Nasdaq adv/dec volume ratio was positive by 4 to 1.
Precious metals heated up yesterday, enabling SPDR Gold Trust (GLD) to close just pennies below the high of its tight, four-week consolidation. If bullish momentum from yesterday’s session follows through, GLD will break out above the high of its recent range, and also move into the territory of a fresh all-time high. Although GLD has a rather extensive history of failing its breakout attempts, one thing we really like about the current price action is how well GLD has been behaving in recent weeks. The consolidation has been tightening up, and last week’s pullback to its 20-day exponential moving average was short-lived. Below is a weekly chart of GLD:
As GLD gained 1.4% yesterday, its sibling, iShares Silver Trust (SLV), zoomed 3.5% higher. Over the longer-term, SLV has shown relative weakness to GLD because it is still well below its all-time high from March of 2008. However, the shorter-term pattern of SLV may be conducive for a nice swing trade over the next week. Check out our annotated daily chart of SLV below:
In the September 28 issue of The Wagner Daily, we pointed out a potential momentum trade that was setting up in iShares 20+ Year Treasury Bond Fund (TLT). At the time, TLT was breaking out above a significant area of horizontal price resistance, and we said it could be bought for a quick momentum trade. If buying it, we specifically said, “TLT could be sold into strength, as it tests its 200-day MA (around $100.40).” Following through on bullish momentum from the breakout, TLT rallied to the area of our target price ($100.31) on October 2 (five days later). Our intended time frame on the trade was short because resistance of the 200-day moving average could be difficult to overcome in the near-term. On the chart below, notice how TLT probed above its 200-day MA on October 2, running stops, then pulled back below that level. We did not “officially” take the TLT trade because we focus on trades with a slightly longer holding period. However, we originally pointed it out for those who like the quicker, shorter-term trades:
In addition to GLD and SLV, another commodity ETF positioned for a high-momentum, near-term rally is U.S. Natural Gas (UNG), which we’ve been long since late September. Yesterday, UNG closed right at the high of its multi-week consolidation, after neatly “undercutting” support of its 20-day exponential moving average (EMA) last week. This puts UNG squarely above its 50-day moving average for the first time in months. If it holds, the intermediate-term bias of UNG will become bullish. Until now, only the short-term trend has been “up.”
On the chart of UNG above, we’ve circled last week’s “undercut” of the 20-day EMA. For educational purposes, let’s talk about the “undercut,” as it is a classic pattern that’s good to watch out for.
When chart patterns are too “obvious,” such as the potential breakout in UNG, big money funds will often move the price in the opposite direction of everyone’s expectations, causing traders’ stop losses to be hit. Meanwhile, the “smart money” scoops up shares at a lower price. Then, one to two days later, the price quickly jumps back into the previous range, as if the preceding break of support never even happened. Rather than being negative, an “undercut” is actually a positive event, as it has the effect of shaking out the “weak hands” who set their stop prices too tightly below the obvious level of support. This subsequently has a bullish effect on the price because overhead supply becomes absorbed, making it easier for the stock or ETF to move higher thereafter. But in order for “undercuts” to be valid, there are a couple things to know:
- The “undercut” should not be more than 3 to 4% below the obvious level of support. On the day UNG broke down below its 20-day EMA, the intraday low was equal to 3.5% below the 20-day EMA. If UNG had fallen more than 5%, for example, we would have been more inclined to label the sell-off as a legitimate break of support, rather than a bullish “undercut.”
- An “undercut” should immediately snap back the following day, at least to the previous day’s high. If it doesn’t, one must wonder what happened to the buying interest that was supposed to follow the shakeout. The day after it broke support, UNG indeed raced back to the previous day’s high, then gapped back into the range on October 6.
- Don’t be afraid to re-enter the position if the “undercut” stopped you out of the trade. In the past, we’ve occasionally made the mistake of having our stop just a bit too tight, therefore causing us to be snagged by the “undercut.” No matter how much thought is put into stop placement, you’re simply going to get snookered every now and then. Yet, this isn’t a problem, just as long as you re-enter the trade upon confirmation of the following day’s reversal back into the range (using a tight stop as well). Granted, you’ll probably be buying back into the trade at a slightly higher price than where you sold, but it doesn’t matter! If the breakout takes off, you may gain 5 points on the trade, rather than 6. But if you don’t re-enter the trade at all, you’ll make 0 points instead of 5. Not a tough decision.
As for the broad market, keep a close eye on the October 2 lows of the major indices. Since those lows converge with support of the 50-day moving averages, it’s critical that the main stock market indexes do not close below their October 2 lows in the coming days. If they do, the broad market will likely have entered into an intermediate-term correction, one that becomes more substantial than other pullbacks in recent months. Conversely, the short-term trends are still down, but another day of gains to push stocks above new resistance of their 20-day EMAs could significantly improve the near-term outlook. For now, we continue to focus mostly on ETFs with a low correlation to the direction of the broad market.
Open ETF positions:
Printing their fourth straight session of losses, the major indices concluded the week with a session of moderate losses last Friday. This time, the decline was exclusively the result of an opening gap down. Thereafter, stocks oscillated in a sideways range throughout the session. The Dow Jones Industrial Average lost 0.2%, as both the Nasdaq Composite and S&P 500 fell 0.5%. The small-cap Russell 2000 and S&P Midcap 400 indices were lower by 0.6% and 1.0% respectively. The Nasdaq finished in the bottom third of the day’s range, while the S&P and Dow closed near the middle of their intraday ranges.
Total volume in the NYSE receded 12%, as turnover in the Nasdaq registered 10% lighter than the previous day’s level. Nevertheless, volume remained above 50-day average levels. Market internals were negative in both exchanges, but not by an overly wide margin. In the NYSE and Nasdaq, declining volume exceeded advancing volume by a margin of 2 to 1.
In our September 30 commentary, we discussed how the major indices had moved into “no man’s land,” trapped between support of their prior lows from August, as well as their 20-day moving averages, and resistance of its previous week’s highs. Specifically, we said, “Overall, this creates an interesting situation we view as a transitional point in the stock market. If the numerous ETFs with patterns similar to those above hold support of their September 25 lows in the coming days, it could very well lead to yet another rally to new highs of the year. But if a plethora of ETFs suddenly start closing below their September 25 lows, the stock market will be peppered with failed breakout attempts that could quickly spark a wave of downside momentum. Tests of the 50-day moving averages could very realistically follow in succession.” The latter scenario is exactly what occurred in last week’s session. Below are annotated charts of the S&P 500, Nasdaq Composite, and Dow Jones Industrial Average:
Summarizing the technical state of the broad market right now, notice the S&P 500, Nasdaq Composite, and Dow Jones Industrial Average all broke support of their “swing lows” from September 25, their 20-day exponential moving averages, and their prior highs from August. Furthemore, the Nasdaq and S&P 500 sliced through support of their primary uptrend lines off the March 2009 lows. The Dow is still slightly hanging on to its six-month uptrend line.
The silver lining to last week’s sell-off is the major indices have already pulled back to support of their 50-day moving averages, as we anticipated they would do upon breaking the short-term support levels mentioned above. The last time the main stock market indexes pulled back to their 50-day moving averages was back in July of this year. When that occurred, stocks traded below their 50-day moving averages for about a week, then began reversing sharply higher. This week, we’ll be closely watching the price action of the major indices to see how they behave on this test of the 50-day moving averages. If stocks appear to hold up, the current retracement provides a low-risk buying opportunity. However, the inability of stocks to hold above their 50-day moving averages would indicate a more substantial intermediate-term correction is falling into place.
Open ETF positions:
Long – DGP, UNG, FCG, DBB
Short – MOO, DUG (an inversely correlated ETF we’re long)
NOTE: Regular subscribers to The Wagner Daily receive daily updates on the open positions above, as well as new ETF trade setups, including trigger, stop, and target prices. Intraday Trade Alerts are also sent via e-mail and/or mobile phone text message on as-needed basis.
Deron Wagner is the head trader of Morpheus Capital Hedge Fund and founder of Morpheus Trading Group (morpheustrading.com), which he launched in 2001. Wagner’s new book, Trading ETFs: Gaining An Edge With Technical Analysis, was published by Bloomberg Press in August, 2008. Wagner also appears on his best-selling video, Sector Trading Strategies (Marketplace Books, June 2002), and is 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. He is also a frequent guest speaker at various trading and financial conferences around the world.
For a free trial to the full version of The Wagner Daily above, which includes detailed ETF trade setups and daily position updates, or to learn about our other newsletters, visit morpheustrading.com or send an e-mail to deron@morpheustrading.com.
NOTE: Regular subscribers to The Wagner Daily receive daily updates on the open positions above, as well as new ETF trade setups, including trigger, stop, and target prices. Intraday Trade Alerts are also sent via e-mail and/or mobile phone text message on as-needed basis.
Deron Wagner is the head trader of Morpheus Capital Hedge Fund and founder of Morpheus Trading Group (morpheustrading.com), which he launched in 2001. Wagner’s new book, Trading ETFs: Gaining An Edge With Technical Analysis, was published by Bloomberg Press in August, 2008. Wagner also appears on his best-selling video, Sector Trading Strategies (Marketplace Books, June 2002), and is 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. He is also a frequent guest speaker at various trading and financial conferences around the world.
For a free trial to the full version of The Wagner Daily above, which includes detailed ETF trade setups and daily position updates, or to learn about our other newsletters, visit morpheustrading.com or send an e-mail to deron@morpheustrading.com.
