Looking for a short? Watch for this…

Stocks followed through on the
previous day’s weakness, as the S&P 500
(
SPX |
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PowerRating) broke support of
its primary uptrend line. The broad market attempted to recover from its opening
gap down by rallying in the early afternoon, but the bears resumed control in
the final ninety minutes of trading. The S&P 500 lost 0.5%, the Nasdaq Composite
(
COMP |
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PowerRating) 0.6%, and the Dow Jones Industrial Average
(
DJX |
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PowerRating) 0.7%. The
small-cap Russell 2000 slid another 0.8%, while the S&P Midcap 400 closed 0.6%
lower. Each of the major indices finished in the bottom third of their intraday
ranges, though the Dow showed relative weakness by closing below its morning
low. Even the StreetTRACKS Gold Trust
(
GLD |
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PowerRating) plummeted 2.5%, causing it to
fail its recent breakout above its 50-day moving average and primary downtrend
line. As such, we made a decision to cut the loss quickly and sell the position
ahead of its original stop.

Turnover rose across the board, causing both the S&P and
Nasdaq to register their second consecutive “distribution days.” Total volume in
the NYSE was 3% higher than the previous day’s level, while volume in the Nasdaq
increased by 2%. Volume has increased in each of the three trading days since
the Labor Day holiday, but institutions have, so far, been selling into strength
of the late August gains. Of the past three sessions, both the S&P and Nasdaq
posted gains on Tuesday, but recall our cautionary comments that the price
action resembled bearish “churning” more than a bullish “accumulation day.” For
astute traders, this was an early warning sign of the losses that followed in
the two subsequent days. Market internals were negative, but not by as wide a
margin as the previous session. In both exchanges, declining volume exceeded
advancing volume by approximately 2 to 1.

In just two days, the S&P 500 has given back the gains of the
past two weeks. Unfortunately for the bulls, this is what commonly occurs when
stocks creep higher with extremely light volume levels. The retail “mom and pop”
investors buy stocks in all market conditions, including the summer doldrums,
simply because they are conditioned to do so. But hedge funds, mutual funds, and
other institutions often see that retail buying interest as an opportunity to
sell into strength when they return back to regular trading activity. That is
why we were reluctant to buy any ETFs in the latter half of August, other than
for quick two to three day momentum plays. It appears our cautious stance was
warranted.

The S&P 500 also closed yesterday firmly below support of its
primary uptrend line that we illustrated in yesterday’s

The Wagner Daily.
The Dow Jones Industrial Average similarly fell below its seven-week uptrend
line as well. In reality, the Dow is a narrow-based index that includes only
thirty blue chip stocks, but it remains a popular index that the general public
views as a barometer for the overall market’s health. As such, we follow the
performance of the Dow simply to keep up with overall market sentiment. The
Dow’s break of its uptrend line is illustrated on the daily chart below (the red
ascending line):

Although the Dow broke support of its uptrend line, notice
that it closed just above its 20-day moving average. This could provide a bit of
support for the Dow, but the problem is that the prior uptrend line has now
become a new area of resistance. If the 20-day MA fails to hold, expect the Dow
to bounce off its 50-day moving average, presently at 11,171. The daily chart
pattern of the S&P 500 is similar to the Dow, except that the S&P actually
closed a few points below its 20-day MA:

If the S&P fails to bounce off this 20-day MA, the next major
area of support should be at convergence of the 50 and 200-day moving averages,
around the 1,276 level. Because each of the major indices formed a “lower high”
off their prior highs from May, the broad market remains in a primary downtrend.
Since mid-July, the indices have been in an intermediate-term uptrend, but the
rally has simply been a strong bounce within the context of the longer-term
downtrend. If looking for a short-selling entry point to take advantage of the
primary downtrend, the break of the intermediate-term uptrend lines provides an
ideal place to do so. Admittedly, we were a bit early to the party by attempting
to sell short a few of the broad-based ETFs while the light volume rally was
still occurring, rather than waiting for the actual resumption of the primary
downtrend. Short sales made in anticipation of key resistance levels often work
well, but you can throw most technical analysis rules out the window when volume
evaporates.

For a low-risk short entry point in the broad market, we would
like to see another day of losses, then a one to two day rally in the early part
of next week. Remember that the prior uptrend lines in the S&P and Dow should
now act as resistance, so a rally up to near those levels would be ideal. If,
however, the indices snap back above their prior uptrend lines, all bets are off
on the short side. For today, we plan to lay low and observe the stock market’s
behavior, especially the relationship between price and volume. We will be ready
to enter a few new positions next week, depending on market conditions.

Open ETF positions:

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 .