The most important rule to follow today

Stocks oscillated between positive
and negative territory Wednesday before
eventually finishing the day modestly higher, but near their best levels of the
session. The Nasdaq Composite
(
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PowerRating), which has fallen the harder than the
S&P
(
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PowerRating) and Dow
(
DJX |
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PowerRating) over the past several weeks, gained 0.6%
yesterday. The small-cap Russell 2000 Index
(
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PowerRating) bounced 0.8% higher, but
the mid-cap S&P 400 continued to show relative weakness by gaining only 0.3%.
The Dow Jones Industrials also advanced 0.3%, but the nominal gain was enough to
enable the blue chip index to close at nearly a five-year high. The S&P 500
moved 0.4% higher.

Unlike the previous session’s bullish "accumulation day,"
total volume declined by 2% in both the NYSE and Nasdaq. However, market
internals were positive in both exchanges. In the Nasdaq, advancing volume again
exceeded declining volume by a ratio of 5 to 2. The ratio was also positive in
the NYSE, but was only slightly better than 3 to 2.

In yesterday’s Wagner Daily, we illustrated that, with
the exception of the Dow, all the major indices were still trading below their
daily downtrend lines from last month’s highs. This still remains the situation
because yesterday’s gains were not enough to push any of the indices through key
resistance of their downtrend lines. However, the S&P 500 closed right at
resistance of its downtrend line from the January 11 high. The daily chart of
SPY (S&P 500 Index) illustrates this:

The most important, yet extremely simple, rule for trend
traders is that we must assume any trend (up or down) will continue until the
index or stock proves otherwise. Therefore, we must assume that resistance of
SPY’s downtrend line will cause a resumption of the current 5-week downtrend
until it proves otherwise. Because of this, SPY’s rally into its downtrend line
now presents us with a low-risk short entry into strength. By shorting near the
current level, stop placement just over the prior high from January 30
represents minimal risk if the downtrend reverses. If, however, the downtrend
resumes, we will be short at the ideal entry price. Shorting downtrending stocks
and ETFs into resistance of their downtrend lines always presents a better
risk/reward ratio than shorting the first break of a support level.

Of the other broad-based indices, both the mid-cap S&P 400 and
Nasdaq 100 indices closed at or just below resistance of their downtrend lines.
This similarly creates low-risk short entries in both MDY and QQQQ. Between the
two, we feel MDY is more attractive because it has been showing more relative
weakness than QQQQ over the past two weeks. Furthermore, MDY has rallied into
resistance of its prior uptrend line that it fell below on February 10. Remember
that a prior support level always becomes the new resistance level after the
support is broken. Therefore, MDY now needs to contend with overhead resistance
of both its primary five-week downtrend line and its prior uptrend line
from the October 2005 low. This is illustrated on the chart below:

As you may have noticed, MDY technically closed a few cents
above its daily downtrend line, but not enough to confirm a breakout of the
downtrend line. The actual S&P 400 Index remains below the downtrend line, but
after-hours trading activity caused MDY to close a bit above its downtrend line.
Regardless, the risk/reward for shorting MDY at this level remains positive due
to resistance of the prior uptrend line. We covered our short position in MDY
for a 2-point gain on February 14, but this bounce into resistance now enables
us to reshort it at a much better price. Regular subscribers should note our
exact trigger, stop, and target prices below.

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