Last Week's Gains Gone In Two Days

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

Stocks heavily built on the prior day's losses yesterday, causing the major indices to erase practically all of last week's gains.  A surprisingly negative ISM report sparked a sharp opening gap down, but the bulls made no attempt to take advantage of the initial weakness.  Instead, the main stock market indexes trended steadily lower for a second straight day.  The S&P 500 suffered a 3.2% decline, the Nasdaq Composite similarly fell 3.1%, and the Dow Jones Industrial Average lost 2.9%.  The small-cap Russell 2000 tumbled 3.0%, as the S&P Midcap 400 settled 2.9% lower.  All the major indices closed at their dead lows of the session.

Total volume in the NYSE surged 22%, while volume in the Nasdaq increased 14% above the previous day's level.  The losses on higher volume were firmly indicative of selling by mutual, hedge, and pension funds.  Turnover also moved back above average levels. In yesterday's commentary, we said of Monday's lower volume losses that, "Though stocks fell on lighter volume, that's not necessarily positive in this situation.  In bear markets, volume typically declines when near-term bounces run out of gas.  The market drifts lower on lighter volume, but the lack of buyers scares the bulls into selling, thereby causing trading activity to increase as the decline picks up steam.  This is a different dynamic than bull markets, in which light volume pullbacks off the highs are bullish."  This is what has happened over the past two days.  Stocks initially fell on lighter volume Monday, but trading picked up substantially yesterday when the bulls became trapped again.

Yesterday, we mentioned that all of the major indices were in danger of breaking support of their hourly uptrend lines off the January lows.  The large opening gap down in the broad market assured that of promptly happening.  This is illustrated on the hourly chart of the DIAMONDS (DIA), a popular ETF proxy for the Dow Jones Industrial Average:

Prior support of the hourly uptrend line annotated above will now act as near-term resistance on any rally attempt the Dow manages to muster in the coming days.  The hourly charts of the S&P and Nasdaq also have similar patterns. If you failed to initiate new short positions yesterday morning and are looking to do so, consider placing a protective stop above resistance of the hourly uptrend lines (just above yesterday's highs).

On the long side, there are very few opportunities with decent looking chart patterns.  With the near-term bounce off the January lows already showing signs of dying, overall odds of profitability favor the short side in the intermediate and long-term.  However, one ETF that actually has a bullish chart pattern is the DB Commodity Index (DBC).  Notice how it is poised to break out from a tight base of consolidation:

While we're not interested in buying ETFs that are correlated to the U.S. stock markets, the nice thing about DBC is it's comprised of a basket of commodities futures contracts, not individual stocks.  Therefore, it moves completely independent of the S&P, Nasdaq, and Dow.  Investing in ETFs with a low correlation to the domestic stock market is one way to diversify and reduce your overall risk exposure.  We'll discuss another non-correlated group of ETFs in tomorrow's Wagner Daily.

The likely direction of the stock market over the next several days is hard to predict.  On one hand, it's bearish that the major indexes surrendered all of last week's gains in just two days.  However, stocks have only done a 38.2% Fibonacci retracement from the January 23 lows to the February 1 highs.  As long as the retracements don't exceed 50%, it would not be surprising to see a rally attempt to reclaim the recent highs.  The best position right now may be cash.  We are showing a 3-point unrealized gain with our position in the UltraShort Dow 30 ProShares (DXD), but we plan to keep a tight trailing stop in order to protect our gains.  Due to the quick move into resistance of its 50-day MA, we already sold our position in the UltraShort Financials ProShares (SKF) yesterday, locking in a speedy 5-point gain.

Open ETF positions:


Long - DXD

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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