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Morpheus TradingMajor Market and ETF Trading |
Don't Avoid Expense ETFs
The stock market closed out last week's session with a bang, as the strong gains of Friday's uptrending session caused both the S&P 500 and Nasdaq Composite to zoom to new highs. The major indices began the day with large opening gaps, then moved steadily higher throughout most of the session. Stock pulled back slightly in the final hour of trading, but all of the main stock market indexes still settled in the upper third of their intraday ranges. The Nasdaq Composite maintained its pattern of relative strength, advancing 1.7%. The S&P 500 and Dow Jones Industrial Average gained 1.0% and 0.7% respectively. The small-cap Russell 2000 cruised to a 1.9% gain, while the S&P Midcap 400 ticked 1.6% higher.
Turnover swelled across the board, enabling both the S&P and Nasdaq to score a bullish "accumulation day." Total volume in the NYSE increased by 15%, while volume in the Nasdaq came in 14% above the previous day's level. Considering that the prior day's trading activity was the lightest in several months, it wasn't surprising that volume increased in both exchanges. Volume also remained below 50-day average levels. Nevertheless, the "accumulation day" helped to lessen the impact of the two "distribution days" (higher volume losses) that the Nasdaq flashed last week. In both exchanges, advancing volume exceeded declining volume by a ratio of approximately 5 to 1. Solid market internals helped to confirm the institutional buying.
Occasionally, we initiate trades in ETFs that are trading at a high share price. The nearly $200 per share Oil Service HOLDR (OIH), which we bought and sold for a profit a few weeks ago, is one such example. Once in a while, I get e-mails from new subscribers, asking me if there are any "lower-priced" alternatives. While there often are, this is a good time to remind traders and investors that share price in a position is largely irrelevant.
When I first began my trading career with individual stocks nearly ten years ago, I was working with very limited capital. With good reason, I was concerned that my total buying power might not be sufficient to make a living trading the stock market. As such, I mistakenly focused on trading only the inexpensive stocks (ETFs were limited at the time).
Though I didn't trade "penny stocks," the issues I traded were typically priced anywhere from $3 to $20 per share. My rationale behind selecting these low-priced stocks was that I would be able to afford to buy more shares, and therefore had greater potential for profit. At the time, my reasoning seemed logical, and I even made some gains by trading those low-priced issues. But, I failed to realize one crucial point -- There was just as much profit to be made by trading higher priced stocks because the higher priced stocks also move proportionately more on a point basis at any given time. Therefore, I could make as much profit buying less shares of an expensive stock, as opposed to more shares of a less expensive stock. The same is true in the current market with ETFs. Consider the following examples.
Example 1: You decide to buy 2,000 shares of an ETF that is priced at just $15 per share. Excluding commission, it would cost you $30,000. If that ETF moves up 4% in value, your gain will be 60 cents per share, making the new price of the ETF $15.60. $15.60 per share times 2,000 shares now gives you a total value of $31,200. This equates to a net gain of $1,200 on a capital investment of $30,000.
Example 2: You buy a higher priced ETF, but since you are limited to $30,000 in capital, you can only buy a limited number of shares. The ETF you want to buy costs $150 per share. Therefore, you are only able to buy 200 shares of this stock So, you buy your 200 shares, and the ETF subsequently moves up 4% in value (same as the previous example). A 4% appreciation gives you a net gain of $6 per share, which now prices the ETF at $156 per share. $156 per share times 200 shares gives a total value of $31,200. Therefore, your overall net profit is $1,200 on capital of $30,000.
As you can see from the above examples, when an ETF moves up or down by any given percentage, your profit potential is not affected by the number of shares owned. A 4% gain is the same profit whether the ETF is cheap or expensive.
Expensive ETFs will proportionately move more points than lower priced issues, but when you look at the gains in terms of percentages, the end results are the same. Obviously, there is nothing wrong with buying ETFs that are inexpensive and meet all the other criteria, but just make sure not to limit yourself. If your capital is limited, you may indeed feel kind of silly buying only a small number of shares at times. I sure did. But the bottom line is the same.
We'll conclude this point with a reminder that higher priced ETFs and stocks are expensive for a reason. They are the leaders of the market because institutions are buying them! Conversely, cheap stocks and ETFs are that way because they're not in demand. Always buy the leaders, not the laggards.
The S&P 500 closed last week at a new historical high, albeit by just a narrow margin. The Nasdaq Composite can retrace more and still hold above its prior high. Though the index flashed two days of institutional selling last week, actual price action remains solid. If already long the market, trailing your stops tighter to protect gains is logical right now. New trade setups on the long side are few and far between, as most ETFs have already run into the upper end resistance of their uptrending channels. "Overbought" conditions can always become even more "overbought" before eventually correcting, but the reward/risk ratios for new long entries here are not that great.
Open ETF positions:Long - LQD, DUG
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 e-mail alerts are also sent 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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