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

The S&P 500 finally broke firmly below support of its recent range last Friday morning, triggering logical entry points for traders on the short side.  But just when we thought it was safe to jump back in the water with a few new positions, the shark of indecision struck again! A massive rally in the final thirty minutes of trading enabled the major indices to erase their intraday losses of more than 1% and close back in the middle of their two-week sideways ranges.  Ripping nearly 2% off their intraday lows in just thirty minutes, both the S&P 500 and Dow Jones Industrial Average finished 0.8% higher.  The Nasdaq Composite, which had deeper morning losses to overcome, gained 0.2%.  Not quite making it back to positive territory, the small-cap Russell 2000 lost 0.1%, but the S&P Midcap 400 ticked 0.6% higher.  All the main stock market indexes closed near their intraday highs.

Turnover in the NYSE was on par with the previous day's level, while total volume in the Nasdaq rose 3%.  Surprisingly, volume did not significantly increase during the powerful rally in the final thirty minutes of trading.  This tells us that institutions such as mutual, hedge, and pension funds were not heavily accumulating shares.  Perhaps they were waiting to see if the market follows through in today's session.  Regardless of the reason volume failed to surge alongside of prices, it appears that much of the strength was simply due to spontaneous short covering caused by the failed morning breakdown.  Advancing volume in the NYSE exceeded declining volume by nearly 3 to 1, but the Nasdaq adv/dec volume ratio remained fractionally negative.

Did the surprise buying spree into last Friday's close surprise you?  If so, you're not alone.  Taking the professional, disciplined route, we waited patiently in cash for several days while the S&P remained in its choppy, sideways range.  When the index finally broke well below support of its recent lows on Friday morning, we initiated our predetermined plan to sell short the S&P 500.  Specifically, we bought the inversely correlated UltraShort S&P 500 ProShares (SDS).  In addition, we re-entered the UltraShort Financials ProShares (SKF) when it broke out above the high of its recent range.  By the closing bell, our SKF trade had already hit its stop price, while SDS came within a few cents of its stop.

Although the outcome of our new trade entries last Friday was negative, it certainly does not mean the trade entries were bad.  In the trading business, one can properly assess the charts of a trade setup and patiently wait for the proper trigger price, but still stop out of the trade shortly after entry.  When I began my trading career nearly ten years ago, I thought I was doing something wrong whenever this occurred.  Fortunately, I quickly learned that professional trading is simply a "numbers game."  If doing everything properly, the law of averages will be your friend over the long haul, but standard deviation makes it impossible to win on every trade, or even close to it, in the short-term.  Consider, for example, that our percentage of winning ETF trades in the fourth quarter of 2007 was only 65%, but our model portfolio still realized a pleasing 18.5% gain.

In order to maintain objectivity when analyzing trades, we have a simple question we ask ourselves to determine whether the negative outcome of a trade was the result of an error on our part, or a negative swing on the law of averages.  That question is, "Despite the benefit of hindsight and negative outcome of this trade, would I still enter the trade again, given the knowledge and technical pattern I had at the time of entry?"  If the answer to that question is a confident "yes," then you should not give the losing trade another moment of thought. It was simply a negative swing in the law of averages.  Upon further analysis of our SKF and SDS trade entries, we would still take the same entries all over again, even though the outcome was negative.  Both setups were clear and well-planned, but they simply didn't work (not yet anyway). Regardless of SKF and SDS, we're still on track for another highly profitable month of ETF trading.

On the daily chart of the S&P 500 SPDR (SPY), notice how the 20-day exponential moving average acted like a magnet throughout last week.  Though the intraday action has been unpredictable from day-to-day, notice how SPY closed very near its 20-day EMA nearly every day last week:

Based on the chart above, one could say stocks merely reverted to the mean all last week.  In this case, the mean is the 20-day EMA, a very reliable indicator of short-term support/resistance for stocks, ETFs, and indexes.

 

On a purely technical level, last Friday's closing action was quite bullish.  All the main stock market indexes fell below lower channel support of their recent "wedge" patterns in the morning, but recovered to close back in the middle of their 2-week trading ranges.  They also formed bullish "hammer" candlestick patterns on their daily charts.  Often, the combination of a bullish reversal back above a key break of support and the formation of a "hammer" leads to further gains in the days that follow.  However, given the erratic state of the market we observed throughout last week, we're hesitant to make any worthwhile predictions.

Perhaps the most valuable near-term advice is to once again avoid new trade entries on either side of the market until the major indices firmly CLOSE above or below their recent ranges.  We could continue to see further intraday "stop hunts" and reversals, but the closing prices carry the most weight.  If we ignore last Friday's intraday pattern, the S&P 500 simply ended the week near the level it started.  This tells us very little. With the bulls and bears battling it out and the major indices at such pivotal levels of support/resistance, a continued focused on capital preservation remains of paramount importance.  There's nothing wrong with dipping a toe in the water if clear setups present themselves, but maintaining adherence to stops and trading with reduced share size will keep potential losses in check.

Open ETF positions:






Long - SDS





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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