Oil: My Scenario

Stocks followed through on the
previous day’s weakness last Friday, causing the S&P 500
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Nasdaq Composite
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each fall below their 50-day moving averages. The Nasdaq dropped 0.8% and again
showed the most relative weakness. Both the S&P 500 and Dow Jones Industrials
slid 0.5%, while the small-cap Russell 2000 and mid-cap S&P 400 indices each
lost only 0.3%. Each of the major indices again closed near their intraday lows,
but most of the day’s losses resulted from an opening gap down as opposed to an
intraday downtrend.

Despite the S&P and Nasdaq both closing below key support of
their 50-day moving averages, it is interesting to note that turnover again
declined in both exchanges. Total volume in the NYSE declined by 4%, while
volume in the Nasdaq was 2% lighter than the previous day’s level. It was the
third consecutive day of lighter volume in the NYSE, which is actually a
positive considering that the index fell 1.4% over the last two days. The Nasdaq,
however, registered a bearish “distribution day” with its 1..3% drop on February
2. Not surprisingly, market internals were negative again. Declining volume
exceeded advancing volume by a ratio of nearly 3 to 1 in the Nasdaq and just
under 2 to 1 in the NYSE.

As subscribers were notified via a real-time e-mail alert, we
shorted OIH (Oil Service HOLDR) last Friday afternoon. The biggest reason for
this trade is that the price of Crude Oil has formed a “lower high” on its
weekly chart, while its last breakout on the daily chart failed to hold. This
tells us that we are likely to see further correction in the price of Crude Oil
in the intermediate-term. Note the “lower high” and failed breakout on the daily
chart of the Crude Oil commodity below:

The Oil Service Index ($OSX) is largely impacted by the price
of crude, but even better is that the index is in the process of forming the
right shoulder of a bearish

“head and shoulders” pattern on its 60-minute chart:

If the $OSX index breaks the “neckline” at the 208 level, we
should see a significant drop in OIH because it mirrors the price of the Oil
Service Index pretty closely. We already shorted OIH as it was forming its right
shoulder on Friday, but a break below the February 2 low would confirm the setup
even more.

Last week’s broad-based losses caused the S&P 500 to close
below support of its 50-day moving average for the first time since November 1,
2005. As you may recall from the February 3 issue of The Wagner Daily, we
felt it was negative that the S&P drifted back down to its 50-day MA only four
days after it bounced off its support on January 26. As such, we anticipated
further downside and a subsequent closing price below the 50-MA, which is
exactly what happened last Friday:

Looking at the chart above, the horizontal dotted line
illustrates pivotal support of the S&P’s prior low. If the index closes below
that 1,261 level, the S&P will have formed a “lower low” that to go along with
last week’s “lower high.” If this occurs, the S&P will have technically entered
into a new intermediate-term downtrend, its first since last October. Obviously,
the S&P could hold above support of its prior low, but overhead resistance of
both the 20 and 50-day moving averages will make it difficult for the S&P to
rally very far. The recent failed bounce off the 50-day MA has created a lot of
overhead supply from traders and investors who expected the support to hold
firm.

The daily chart pattern of the Nasdaq is very similar. Like
the S&P, the Nasdaq formed a “lower high” last week and failed to hold above its
50-day moving average. The 2,247 level represents the January closing low, so a
break below that level would correspondingly give the Nasdaq its first “lower
low” as well. Looking at the broad market overall, we continue to feel that odds
favor additional downside in the short and intermediate-term. Be sure to cut
your losing positions quickly by simply honoring your stops. When the major
indices are trading below their 50-day MAs, one can never assume that your
winning long positions will “eventually come back” if they start to drop.