Our Two Bearish ETF Positions

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

After just a one-day bounce off its recent lows, the broad market got slammed again. Stocks drifted lower in the morning, briefly stabilized at mid-day, then plummeted to new short-term lows in the final ninety minutes of trading. The Dow Jones Industrial Average fell 2.1%, the Nasdaq Composite dropped 2.5%, and the S&P 500 skidded 2.7%, breaking well below its 200-day moving average in the process. Small and mid-cap stocks, both of which have been showing the most relative weakness since the current downtrend began, continued to get pummeled. The Russell 2000 plunged 3.6%, while the S&P Midcap 400 lost 2.9%. Capping three straight weeks of losses, all the major indices finished at their lowest levels of the week. Since peaking in mid-July, the S&P 500 has shed 7.7%, the Nasdaq Composite 7.2%, and the Dow Jones Industrials 5.2%. The small-cap Russell 2000 has lost a whopping 11.8% over the past three weeks!

As has been the case with most of the past month's losing days, turnover ticker higher. Total volume in the NYSE and Nasdaq increased over the previous day's levels by 7% and 3% respectively. As long as volume remains light on most of the "up" days and heavier on the "down" days, one simply cannot expect the stock market to find solid ground. However, when stocks eventually put together a few "accumulation days" marked by higher volume gains, it will be our first clear sign that institutional selling is drying up. Until that happens, it is crucial to remain vigilant with any entries on the long side of the market. With roughly 9 out of 10 stocks moving lower in the current market, overall odds clearly favor selling short into bounces, rather than buying the short-lived retracements off the lows. At the very least, consider being fully positioned in cash until the market gives a few clear signals that a bottom may be forming.

Over the past several days, we have been stalking the Semiconductor HOLDR (SMH) for a potential long entry if it moved back above its 50-day moving average and hourly downtrend line. Fortunately, the pre-determined entry price we detailed to subscribers never triggered. On Friday, SMH lost 2.1% and closed at its lowest level since mid-June. Even though it formed two bullish "hammer" candlesticks just below its 50-day MA, notice how SMH never moved back above that pivotal level that was required in order for us to buy:

By forcing SMH to first confirm its bullish reversal above the 50-MA, rather than haphazardly trying to pick a bottom, we avoided entering what would have become a losing trade. Particularly in a weak market, it's extremely important to patiently wait for proper entry triggers to present themselves. Anxiously "jumping the gun" to buy a stock or ETF at a "better price" will only lead to your account being chopped up. For now, SMH has been removed from our long watchlist as a potential near-term momentum play.

Presently, we are positioned in two ETFs, both showing marked-to-market gains on the short side. On August 1, we sold short the iShares Emerging Markets Index (EEM) after it fell below both its primary uptrend line and 50-day moving average. The following day, EEM feebly attempted to move back above its 50-day MA, but it collapsed on Friday. On the daily chart below, notice how EEM has broken down to a new "swing low" and has firmly established the 50-day MA as new resistance as well:

The EEM short position is currently showing an unrealized gain of nearly 3.5 points, but our downside price target is just above the 200-day MA (the orange line). As always, we will be trailing a stop along the way in order to protect profits while maximizing gains.

In addition to EEM, we also entered a new short position in the S&P Midcap 400 Index last Friday. Like the benchmark S&P 500, the S&P Midcap 400 also fell below its 200-day MA, confirming our short entry. Rather than simply selling short the S&P Midcap SPDR (MDY), we bought the inversely correlated UltraShort MidCap 400 ProShares (MZZ). Like all the other ETFs in the ProShares UltraShort family, MZZ is designed to move in the opposite direction of the S&P Midcap 400 Index, and at a 2 to 1 ratio. As such, MZZ rallied 5.8% on Friday while the S&P Midcap 400 Index dropped 2.9%. For those who are not familiar with them, the main benefit of the UltraShort family of ETFs is that they enable investors to easily take bearish positions on the stock market in their IRAs and other non-marginable retirement accounts that prohibit short selling. The daily chart below illustrates how MZZ broke out above its 200-day MA (just as the underlying index fell below its 200-day MA):

For the first time since the month-old downtrend began, market internals last Friday reached the kind of extreme levels that often precede a short-term bottom. The NYSE TRIN, a measure of stock market strength that relates the number of stocks that advanced or declined to the total number of shares that advanced or declined, shot up over 3.0. Generally speaking, a TRIN reading under 1.00 is bullish and a TRIN over 1.00 is bearish. However, when the TRIN starts to go much beyond 2.0, this extreme level often acts as a contrarian indicator that a short-term bottom is near. Last Friday's atrocious declining volume/advancing volume ratio in the NYSE, nearly 20 to 1, also was too extreme. Obviously, this doesn't guarantee the market will bounce today, especially given the degree of last week's technical damage. Nevertheless, the risk/reward of entering new short positions at current price levels is not very good. There is also a meeting of the Federal Reserve Board tomorrow, so traders may remain on the sidelines ahead of that statement on economic policy.

Open ETF positions:

Long - MZZ
Short - EEM

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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