Stalking a Short Position in the QQQQ

The Nasdaq Composite snapped its three-day losing streak last Friday, but its small 0.3% rebound recovered only 20% of its previous day's loss. The S&P 500 also gained 0.3%, but the modest advance was enough to recover all of its loss from the prior session. The Dow Jones Industrial Average began to lose its recent relative strength by closing less than 0.1% lower. The small-cap Russell 2000 and S&P Midcap 400 indices led the broad market with gains of 0.9% and 0.7% respectively. Each of the major indices finished in the upper third of their intraday ranges.

After two consecutive "distribution days" in the Nasdaq last week, Friday's recovery attempt was a positive sign, but the significantly lower turnover that accompanied it was not. Total volume in the Nasdaq was 11% lighter than the previous day's level, indicating a lack of institutional participation in the rally attempt. Lower volume gains that follow higher volume selloffs indicate a temporary break in the selling pressure, as opposed to fresh buying interest. Obviously, this is not encouraging for the Nasdaq. Total volume in the NYSE actually increased by 1%, but the marginal volume increase was not enough to label the session as a bullish "accumulation day." Market internals were positive, but not by an overwhelming margin. Advancing volume in the Nasdaq exceeded declining volume by 3 to 2, while the NYSE ratio was positive by 2.3 to 1.

Less than two weeks after bouncing off support of its 50-day moving average and jumping to a new six-year high, the Nasdaq Composite is once again testing pivotal support of its 50-day MA. The Nasdaq actually touched its 50-day MA on Friday morning, but closed above it. Over the next several days, traders and investors will definitely be focused on whether or not the 50-day MA once again "does its thing" by enabling the Nasdaq to rally off its support. But unlike the initial bounce (resistance) has been created that was not a factor when the Nasdaq was merely consolidating and correcting by time throughout December. When the index corrected in the latter half of last week, its inability to hold support at the 2,470 level was bearish. Expect any rally attempt into the prior high of 2,470 to be met with selling pressure from traders who became trapped in the recent failed breakout. The red horizontal line on the daily chart below marks the Nasdaq's short-term resistance level, while the blue horizontal line illustrates the next support level if the index breaks below the 50-day MA:

The Nasdaq 100 Index, which is more concentrated on tech stocks than the broader-based Nasdaq Composite, is showing a similar chart pattern. Like the Nasdaq Composite, a break below last Friday's low in the Nasdaq 100 would coincide with a break below its 50-day moving average. As such, the Nasdaq 100 Tracking Stock (QQQQ | Quote | Chart | News | PowerRating) may be setting up for a short sale if it breaks below last Friday's low:

Waiting for a breakdown below the 50-day MA before selling short forces the Nasdaq 100 to confirm its failed breakout, but more aggressive traders could also consider selling short a partial position of QQQQ on a rally into resistance at the 44.80 area. Be aware, however, that a short entry into strength carries a greater degree of risk.

If you happen to take a short position in the Nasdaq 100, don't forget that both the ProShares Ultra QQQ (QLD | Quote | Chart | News | PowerRating) and the UltraShort QQQ ProShares (QID | Quote | Chart | News | PowerRating) may be better alternatives than selling short QQQQ. QLD offers more "bang for your buck" because it is leveraged at a 2 to 1 ratio to the Nasdaq 100. If, for example, the Nasdaq 100 drops 1%, QLD will fall approximately 2%. Obviously, this works in both directions. QID is similar to QLD because it is also leveraged at a 2 to 1 ratio, but it also is inversely correlated to the direction of the Nasdaq 100 Index. Buying QID is essentially the same as selling short QLD. The ProShares Short QQQ (PSQ | Quote | Chart | News | PowerRating) is also inversely correlated to the direction of the Nasdaq 100, but is not leveraged like QID. Because traditional retirement accounts such as IRAs are non-marginable, they do not enable investors to sell short. However, the UltraShort ProShares ETFs, such as QID and PSQ, offer a great way to get around that issue. A complete list of the ProShares Funds can be found by downloading our free Morpheus ETF Roundup guide.

For the past four days, the S&P 500 has been trading in narrow, sideways range, right at resistance of its prior high from last December. Clearly, its chart pattern now looks a lot better than the Nasdaq's, but rapid downward momentum could set in if it fails to break out to a new high within the next several days. A break below last week's low of 1,424 would most likely trigger a selloff that takes the S&P down to support of its 50-day MA, presently at the 1,408 level:

Corporate earnings season is now kicking into high gear, as more than one hundred companies in the S&P 500 will show their quarterly report cards to the world within the next two weeks. Tech giants Yahoo! and eBay are among the slew of companies reporting within the next few days, so we'll see if they receive the same dismal reaction that Apple and Intel did last week.

Open ETF positions:

Short EEM, 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 .