More Commodity ETFs Setting Up For Breakout

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

A volatile and erratic day sent the broad market firmly lower yesterday, as turnover picked up across the board. After gapping lower on the open, the major indices fell even more when Fed Chief Ben Bernanke testified to Congress about the U.S. economy at 10:30 am EDT, but the bearish reaction was initially short-lived. Stocks found support less than thirty minutes later and began to reverse, enabling both the S&P and Nasdaq to set new intraday highs by mid-day. But just when the market appeared to have blown off the negative reaction of the morning, stocks rolled over again, eventually causing the major market indexes to finish near their morning lows. The S&P 500, Nasdaq Composite, and Dow Jones Industrial Average each shed 0.8%. The small-cap Russell 2000 lost 0.6% and the S&P Midcap 400 declined 0.4%. Yesterday's session was equivalent to riding a roller coaster, but the bears won the tug-of-war in the end.

Total volume in the NYSE was 10% higher than the previous day's level, while volume in the Nasdaq swelled by 17%. The substantial losses on higher volume caused both the S&P and Dow to register a bearish "distribution day" that was indicative of institutional selling. Market internals were solidly negative. In both the NYSE and Nasdaq, declining volume exceeded advancing volume by a ratio of approximately 7 to 2. It was bullish that turnover surged higher in both exchanges when the market ripped on March 21, confirming the broad market's bullish reversal off its March lows. It was also positive that volume dried up on most of the consolidation days that followed, including the moderate session of losses on March 27. However, yesterday's action changed the technical picture for the worse.

Yesterday, we re-iterated that we were stalking the Oil Service HOLDR (OIH) for a pullback that would provide us with a low-risk buy entry. It gapped higher on the open, but sold off with the rest of the stock market, finishing below its low of the previous day. The intraday action tells us that a retracement down to the hourly uptrend line may be in the works, or at least a decent sideways consolidation ("correction by time"). We'll continue monitoring OIH for the ideal entry point, but a related ETF, the U.S. Oil Fund (USO), just broke out yesterday:

USO, which loosely follows the price of the crude oil commodity, gapped up above a band of horizontal price resistance and closed yesterday at its highest level of the calendar year. If the breakout holds, momentum should carry USO at least to its 200-day moving average, which nearly converges with the prior high from December 1. For your information, USO is correlated to the price of a basket of crude oil futures contracts, not the exact price of spot crude. Unlike the StreetTRACKS Gold Trust (GLD), which actually invests in physical gold, USO does not move in lock-step with the price of the crude oil commodity. In fact, it has lagged the price of spot crude for quite some time.

As you can see on the chart above, USO closed near its intraday low. Obviously, that never a good sign. Nevertheless, it still held above its breakout level of 51.68 (the blue dashed horizontal line). Though it's common for stocks and ETFs to dip below their pivots on an intraday basis, breakouts often fail when there is a closing price below the breakout level. Therefore, buying USO near its current level provides a very high risk/reward ratio, just as long as you set a stop just below the 51.68 breakout level. Be sure to give your stop some intraday "wiggle room," but don't have it too loose that the risk/reward on the trade suffers.

GLD gapped up above its consolidation and triggered our long entry yesterday, though it too failed to make any intraday progress. With commodities such as Gold and Oil showing bullish patterns, it makes sense that other commodities are showing strength as well. Take a look at weekly chart of the DB Commodity Index Tracking Fund (DBC):

It's been a bit range-bound and choppy over the past year, but a clearly defined downtrend channel has been formed from the peak of May 2006. As you can see, DBC is once again approaching resistance of that downtrend line, so watch for a possible breakout. The higher low that has formed since the last test of the downtrend line is one reason we think DBC will actually break out this time, rather than resuming its long-term downtrend.

Not only did we see institutional distribution in the market yesterday, but both the Nasdaq and Dow gave back all of their gains from the post-Fed rally that began on March 21. The S&P 500 retraced "only" 85% of its post-Fed gains. In the March 22 issue of The Wagner Daily, I wrote the following: ". . .it may be risky to buy heavily at current levels without first seeing if yesterday's Fed bonanza was merely an unsustainable knee-jerk reaction." Usually, a gut reaction to an FOMC meeting will undo itself within two to three days. This time, it took a few days longer. Nevertheless, for all practical purposes, consider the broad market to be back where it was before the Fed fired everyone up. All the major market indices except the S&P Midcap 400 are back below their 50-day moving averages. This has caused the short-term trends to switch from "up" to "down," which now coincides with the intermediate-term trends as well. The next week should be interesting.

Open ETF positions:

Long DXD, GLD, short IYR, FXI (regular subscribers to The Wagner Daily receive detailed stop and target prices on open positions and detailed setup information on new ETF trade entry prices. Intraday e-mail alerts are also sent as needed.)

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. For a free trial to the full version of The Wagner Daily or to learn about Deron's other services, visit morpheustrading.com or send an e-mail to deron@morpheustrading.com .

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