A Biotech Bonus

NOTE: Please click on the charts below to enlarge them if they do not appear clearly.

Stocks kicked off the week in uneventful fashion, as the major indices opened slightly higher, drifted lower throughout the morning, then chopped around in a sideways range throughout the rest of the day.  Like the previous session, the main stock market indexes finished with mixed results.  Both the S&P 500 and Nasdaq Composite lost 0.1%.  The Dow Jones Industrial Average declined 0.3%.  The small-cap Russell 2000 and S&P Midcap 400 indices showed relative strength by scoring identical gains of 0.7%.  The S&P 500, Dow Industrials, and Nasdaq Composite all settled in the bottom third of their intraday ranges.

Turnover receded to its lightest levels in weeks.  Total volume in the NYSE declined 30%, while volume in the Nasdaq limped in 18% below the previous day's level.  In both exchanges, trading dropped well below 50-day average levels.  However, the lower turnover was positive because it was basically just a consolidation day.  Higher volume with little changed prices would have pointed to "churning," a bearish event that occurs when stocks rally, then trade sideways on increasing volume.  In both the NYSE and Nasdaq, advancing volume was on par with declining volume. 

On July 15, we bought the UltraShort Oil and Gas ProShares (DUG), which moves in the opposite direction of the energy sector.  However, we scratched the trade intraday due to bullish reversal that was brewing in the broad market.  Even though the oil sector was weak that day, we were concerned that energy issues would get a solid boost from general strength in the broad market regardless. We were wrong.  The oil-related ETFs continued to fall apart throughout the day, propelling the inversely correlated DUG higher.  Oil moved lower over the next two days, but stabilized and began to bounce higher on July 18.  Now out of sync with the broad market, the oil sector continued bouncing yesterday as well.  This caused DUG to pull back to support of its uptrend line off the July 2 low, as well as its 10-day moving average.  This is shown on the daily chart of DUG below: 

Now that DUG has nearly retraced back to the level we bought it at last week, the convergence of 10-day MA and trendline support makes it a low-risk buy entry at its current level (remember that buying DUG is basically the same as selling short the oil and gas sector). Nevertheless, despite the short-term trade setup, realize we are not suggesting oil has definitively formed a top.  The correction in oil shares simply has not been substantial enough to make such an assessment.  Rather, DUG is merely presenting itself as a short-term setup that astute traders may profit from.  If buying DUG here, a relatively tight stop can be placed just below the 20-day exponential moving average (1.5 points below yesterday's close). If DUG rallies back to test its July 17 high, selling into strength of the quick move would net you a gain of about 4 points.  A risk of 1.5 points with a potential reward of 4 points means the reward/risk ratio on the setup is better than 5 to 2 (4 points / 1.5 points).  For all trades, whether short or long-term, we look for reward/risk ratios of at least 2 to 1.

As expected, Biotech HOLDR (BBH) gapped sharply higher on yesterday's open.  News of the Roche acquisition offer of Genentech (DNA) caused BBH to open 6.4% higher.  Per real-time Intraday Trade Alert to Wagner Daily subscribers, we sold into strength of that move a few minutes later, netting a gain of more than 19 points (11.2%) on the trade!  Admittedly, a bit of luck contributed to that massive winner.  However, we originally bought BBH due to relative strength in the biotech sector, which led to a breakout in BBH.  The Genentech news was just icing on the cake.

We're smack in the middle of quarterly earnings season.  That means lots of surprises and opening gaps from day to day.  After yesterday's close, Apple (AAPL) trumpeted their latest report card.  Though they beat earnings estimates, they lowered their forward-looking expectations.  This did not please Wall Street.  In the after-hours market, AAPL was last seen trading approximately 10% below yesterday's closing price of $166.29.  Regardless of whether or not you have a position in Apple, this is noteworthy.  Google, Microsoft, and Apple all had disappointing news within the past three days.  When market leading stocks such as Apple start falling apart, it acts as an anchor on the entire broad market (especially the tech-heavy Nasdaq).  We're not saying last week's rally attempt off the lows is already dead, but we have not yet seen any indication that it was anything more than a very short-term, counter-trend bounce.  Either way, we welcome the direction of the stock market's next move because we trade what we see, not what we think!

Open ETF positions:

Long - GLD, RSX

Short - (none)

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 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.  Wagner is currently working on this third book, scheduled for publication in early 2008.

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.

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