The indecisive, range-bound chop of the preceding several days resolved itself yesterday, as the main stock market indexes made a decisive move. Unfortunately for the bulls, the break of the range was to the downside. A worse than expected Consumer Sentiment reading sparked a swift drop after the first thirty minutes of trading. Thereafter, stocks continued lower into mid-day, then found a bit of support in the afternoon. The Dow Jones Industrial Average lost 1.0%, the S&P 500 1.2%, and the Dow Jones Industrial Average 1.3%. The small-cap Rusell 2000 snapped its nine-day winning streak with a 1.1% decline. The S&P Midcap 400 shed 1.3%. All the major indices finished just off their lows of the session. Yesterday was the biggest average percentage decline in the broad market since February 4, one day before the recent “swing low” support levels were established.
Turnover climbed across the board, causing both the S&P and Nasdaq to register a bearish “distribution day.” Total volume in the NYSE swelled 14%, while volume in the Nasdaq rose 19% above the previous day’s level. The higher volume losses pointed to broad-based selling amongst mutual funds, hedge funds, and other institutions. Ugly market internals confirmed the bearishness. In the NYSE, declining volume exceeded advancing volume by a margin of nearly 7 to 1. The Nasdaq adv/dec volume ratio was negative by approximately 5 to 1.
For the past four days, we’ve been patiently waiting for a low-risk entry point to initiate a near-term short position in the broad market. For three days in a row, we were ready to take a bearish position, but each time our trigger price of breaking the previous day’s low did not hit. That patience prevented us from getting short too early and kept us out of trouble. Yesterday, however, our patience paid off, as we finally got the entry point we’ve been waiting for. Upon spotting the confirmation of higher volume as stocks broke support in the morning, we shorted the Nasdaq 100 Index (QQQQ), via a long position in ProShares Short Nasdaq 100 (PSQ), a non-leveraged “short ETF” that inversely tracks the price of QQQQ. Our entry into PSQ coincided with QQQQ breaking below support of the lows of its very short-term trading range, as well as a breakdown below the 20 and 40-period moving averages on the hourly chart. Our entry is annotated on the hourly chart below:
Just because we entered a new short position does not mean we’ve suddenly become bearish on the market. Rather, we’re simply looking to play the momentum of a short-term pullback off the February 5 lows. If selling momentum really kicks in, it’s entirely possible stocks could fall to test support of their February 5 “swing lows,” our ultimate downside target. However, it may be more likely that the major indices do a Fibonacci retracement of 50% to 61.8% of their recent gains, then attempt to head back up again. Closing at its 20-day exponential moving average, QQQQ has so far retraced about a quarter of its rally off the February 5 lows. Regardless of how deep the correction carries stocks, we will manage this short position closely, through the use of trailing stops, because we only intended it to be a short-term trade. In addition to daily updates in this newsletter, we’ll keep subscribers updated, on an “as-needed” basis, through the use of Intraday Trade Alerts.
Shortly after yesterday’s open, we dipped a toe in the water with another “short ETF,” ProShares UltraShort Emerging Markets (EEV). As with the PSQ trade, we’re only looking for a quick “pop” in EEV, and will carefully manage the position with a short-term horizon. The daily chart of EEV below illustrates our buy entry, just above the highs of the tight, four-day consolidation, with the 50-day moving average providing support below:
It may soon be time to take profits on U.S. Dollar Bull Index (UUP), a currency ETF we’ve been long for the past six weeks. Although UUP closed at its highest level since July of 2009 yesterday, the pattern on its daily chart shows it may be time for a period of consolidation. Take a look:
The biggest problem with this chart is the February 19 action, where UUP gapped open well above the range, but sold off intraday to close right at the breakout level. After not doing much the following day, UUP crawled its way back up yesterday, but now must contend with overhead supply from the February 19 high. This puts UUP in danger of a failed breakout, and gives us a valid reason to now trail our stop tightly. While UUP may be in good shape if it gaps back above the February 19 high and holds, we’re now moving our stop to just below yesterday’s low, in order to maximize our gains, and get out near the top, in the event UUP slides back down.
Over the past week, we’ve been reminding subscribers of the dangers of light volume rallies, such as the present advance off the February 5 lows. Specifically, we’ve said that just a single day of higher volume selling (aka “distribution”) can wipe out days of gains that were made on declining volume. Yesterday’s action was a good example of this, as the major indices erased four days of gains in just one session. While stocks made a statement with yesterday’s high volume break of support, the degree of downside follow-through remains to be seen. Certainly, it’s imperative to observe protective stops on any long positions right now. However, it’s equally important to avoid complacency with any new short positions you may have entered. Stay alert and remember to trade what you see, not what you think.
Open ETF positions:
Long – UUP
Short (including inversely correlated “short ETFs”) – PSQ, EEV
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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