Bullish momentum from last Friday’s rally proved to be very short-lived, as the major indices sold off sharply yesterday, giving back nearly all their previous day’s gains. Stocks opened slightly lower, recovered thirty minutes later, then turned tail and entered into a steady downtrend that persisted throughout the entire session. The Dow Jones Industrial Average shed 1.4%, the S&P 500 1.5%, and the Nasdaq Composite 1.6%. The small-cap Russell 2000 and S&P Midcap 400 indices plunged 2.4% and 1.8% respectively. Each of the main stock market indexes closed at its dead low of the day.
Total volume in the NYSE eased 26%, while volume in the Nasdaq was 28% lighter than the previous day’s level. Turnover in both exchanges was well below average levels. In the Nasdaq, it was also the lightest volume day of the year. The quiet pace of trading means institutions remained on the sidelines, and were not active participants in yesterday’s sell-off. As we’ve mentioned several times in recent weeks, trading in the latter half of August is traditionally slow, and usually remains that way until after the Labor Day holiday. Despite the light turnover, market internals were ugly. In the NYSE, declining volume trounced advancing volume by more than 12 to 1. The Nasdaq adv/dec volume ratio was negative by approximately 5 to 1.
In the August 26 issue of The Wagner Daily, we said, “The inversely correlated ProShares UltraShort Europe (EPV) has broken out above a three-month downtrend line, and has also reclaimed support of its 50-day moving average. This positions the ETF for potential buy entry in the near future, in anticipation of a new, intermediate-term uptrend.” We then said we’d ideally like to buy EPV on a pullback that “undercuts” support, thereby providing a lower risk entry point than buying a breakout of consolidation. When the U.S. markets rallied last Friday, EPV pulled back to “undercut” support of its 50-day MA, but closed right at new support of the prior downtrend line, as well as its 20-day exponential moving average. As such, we bought EPV on yesterday morning’s open, and the ETF subsequently trended higher intraday. The daily chart of EPV below illustrates the setup and entry:
As has been the case for the past several weeks, the Philadelphia Semiconductor Index ($SOX) continues to exhibit substantial relative weakness to the broad market. Yesterday, the $SOX closed at its lowest level since February 5 of this year. As such, the inversely correlated UltraShort Semiconductor ProShares (SSG) rallied to close at its highest price since the same period. Below, the weekly chart of SSG illustrates the recent breakout above a major level of horizontal price resistance:
The beige line on the chart above is the 40-week moving average, a long-term indicator of trend change, similar to the 200-day moving average. We bought SSG on August 19, after it “undercut” its 40-week moving average, which it rallied above the week before. Presently, our SSG position is already showing an unrealized gain of 1.6 points, but our near-term price target is substantially higher. The dotted red line marks the area of our price target, which is resistance of the late January/early February highs. Subscribers who missed our original entry point might consider buying SSG on any pullback to the area of its breakout (around $19 to $19.20). A positive reward/risk ratio on such an entry point would still be maintained if a stop was placed below support of the 40-week MA.
In our August 25 commentary, we said, “The major indices made a technically significant move yesterday (August 24), with a confirmed breakdown below horizontal price support levels. . .This increases the odds of further follow-through to the downside, most likely a retest of the July 2010 lows. However, this does not necessarily mean it will happen today, or even with the next few days. . .we think there’s a good possibility stocks will try to stage a short-term bounce and catch the bears off guard, now that the broad market has broken down below an obvious level of support. Thereafter, however, another leg lower could be in the cards.”
So far, the analysis in the paragraph above is pretty much how overall market price action has played out since then. The August 24 break of technical support did not result in an immediate slide to the July lows. Rather, the broad market bounced slightly the following day, then rallied more substantially on August 27. However, based on yesterday’s bearish action, the very short-term bounce we anticipated on August 25 may be finished. Since stocks have merely moved sideways over the past five days, consolidating near their recent lows, odds favor an impending resumption of the downtrend from the August highs. Again, a test of the July 2010 lows of the four-month trading range is probably in the cards, and such a move could be an ideal level to take profits on any short positions into weakness, while considering new long entries in ETFs with relative strength. Until the market proves otherwise, one must assume the multi-month sideways range will continue. Therefore, selling near upper channel resistance of the range, and buying near lower channel support, is the best way to increase your chances of profitability in this environment.
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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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