Two Choices For Protracted Down Market

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

After gapping down on the open, the broad market attempted to recover throughout the morning, but stocks ran out of gas just before noon. Sellers subsequently took control, causing the major indices to careen past their opening lows shortly thereafter. Selling pressure intensified in the late afternoon, where the broad-based indexes eventually closed at their intraday lows. The S&P 500 suffered a 3.0% decline, the Dow Jones Industrial Average 2.8%, and the Nasdaq Composite 2.2%. The small-cap Russell 2000 fell 1.4% and the S&P Midcap 400 lost 2.3%.

The most troubling thing about yesterday was not just the size of the losses, but the fact that turnover in the NYSE rose 8% above the previous day's already inflated level. A 1% retreat in Nasdaq volume enabled that exchange to dodge a "distribution day." According to our research, yesterday's volume in the NYSE of 2.8 billion shares marked a new record high level, marginally exceeding the number of shares that changed hands on July 24, 2002. In the July 27, 2007 issue of The Wagner Daily, we mentioned that the prior day's volume was the second highest ever. We also mentioned that as one of the reasons we felt the stock market would see further losses, which it has. Since turnover pushed even higher yesterday, you can read between the lines to see the implication that makes. With yesterday's record volume that corresponded to a 3% decline in the S&P, it is difficult to imagine the market recovering sooner rather than later. Simply put, there is too much supply being left behind from the massive institutional distribution of the past month.

If the market's current downtrend turns out to be rather protracted, you will have only two sensible options for your portfolio. The first is to sit in cash. A cash position may be boring, but we're in this business to consistently make profits, not for thrills. Cash is king because it can prevent you from giving back all of your hard-earned profits from the recent bull market! The second option, a bit more challenging but potentially more profitable, is to selectively sell short ETFs with relative weakness when they bounce into key resistance levels. This is what we did by selling short the Russell 2000 on August 8 and the Dow Jones Industrials on yesterday's open. If you choose to sell short the stock market's bounces, be sure you're familiar with an innovative family of ETFs known as the ProShares Short and UltraShort funds.

Before the creation of the ProShares Short and UltraShort ETFs, your options were very limited if you wanted to take bearish positions in an IRA or other non-marginable investment account. Selling short requires a marginable account, but current laws prohibit most retirement accounts from being marginable. The ProShares Short and UltraShort ETFs solve the problem because they are inversely correlated to a sector or index. If, for example, the underlying index drops 1%, the corresponding ProShares Short ETF will gain 1%. The only difference between the Short and UltraShort ETFs is that the latter is also leveraged at a 2 to 1 ratio. Therefore, an UltraShort ETF will gain 2% if the underlying index drops just 1%. When this family of ETFs was first launched, the offerings were limited to only the broad-based indexes such as the S&P, Dow, and Nasdaq. Recently, however, the family has grown to include ETFs that are inversely correlated to industry sectors such as Financials, Semiconductors, Utilities, and more. For a complete list of the current Short and UltraShort offerings, please check out proshares.com. We are not affiliated with ProShares in any way, but simply wish to spread the word about this innovative product offering that perfectly fits the bill in the current market environment.

In just one session, the S&P 500 erased approximately 75% of its three-day retracement off the August 6 low. It's positive that the index is still holding above its prior low, but there's a good chance it will test its August low within the next several days. Support of the 200-day moving average may be the only thing that prevented the S&P from doing so yesterday. As you can see, the S&P 500 closed right at pivotal support of its 200-day moving average:

Although yesterday's losses were ugly, nothing really changed on an overall technical level. Obviously, the broad market remains in an intermediate-term downtrend. Because all of the major indices held their prior lows from August, we are technically still in the short-term uptrend that began four days ago. Of course, those short-term uptrends are in jeopardy of breaking if the selling persists through today. Even the wide intraday ranges of the major stock market indexes remains the same. At first glance, one might be shocked to see the S&P 500 down 3% yesterday, but the index gained 2.4%, nearly the same percentage, on August 6. To the delight of daytraders who thrive on intraday volatility, we've been experiencing a significant range expansion since the correction began last month. Unfortunately, this is trickier for swing and position traders who prefer smooth, steady trends.

Open ETF positions:


Long - PBW, DXD, RWM

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 .

1 Comments:

lisitdelr

posted by bogetdelr @ 08/15/2008 08:14AM

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