A Good Shorting Opportunity For You

After beginning the day with an
opening gap down, the major indices promptly
reversed and rallied throughout the morning, but afternoon sell programs caused
the broad market to fall sharply in the afternoon. The Nasdaq Composite had
rallied to a 0.9% gain at mid-day, but major relative weakness in both the S&P
and Dow acted as an anchor and dragged the Nasdaq down to a closing loss of
0.4%. The Dow Jones Industrial Average, which significantly lagged behind the
Nasdaq
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afternoon, eventually closing with a 0.8% loss. The S&P 500 Index
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0.7%. The S&P 400 Mid-Cap Index and the Russell 2000 Small-Cap Index, which
showed mid-day gains of 0.9% and 1.1% respectively, both plummeted in the
afternoon and closed 0.1% lower.

Yesterday’s erratic and wild volatility was also accompanied
by a large volume spike in both exchanges. Total volume in the Nasdaq rocketed
28% higher, while volume in the NYSE surged 15% higher than the previous day’s
level. The increase in volume across the board means that yesterday registered
as a bearish “distribution day” for both the S&P 500 and Nasdaq Composite. In
the Nasdaq, it was the fourth such day of institutional selling within the past
four weeks, while the S&P has had three “distribution days” within the same
period. A healthy market can usually absorb one or two days of higher volume
losses, but uptrends can easily reverse when the broad market has sustained four
or more “distribution days” within a one month period. As we have seen over the
past couple of days, market internals were strong in the morning, but became
negative in the late afternoon. The difference this time, however, is that
volume in both exchanges exceeded 50-day average levels. The sharp rise in
volume confirms the validity of yesterday’s sell-off.

If you actively traded yesterday’s session, it surely kept you
on your toes! If you came into the day mostly short, you probably were forced to
cover many of your positions by mid-day, only to have them collapse in the
afternoon. Worse is that perhaps you covered your short positions and went long,
reasonably thinking the Nasdaq was finally bouncing off its 50-day MA, only to
find yourself taking losses on both sides of the market. If so, don’t feel too
bad about it. Without a doubt, yesterday was equally tricky for both the bulls
and bears! Hopefully you heeded our recent advice and were positioned mostly in
cash, or at the very least, avoided trading the broad-based ETFs such as SPY
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As for the Wagner Daily plays, the morning rally caused
the RTH short to hit its trailing stop, but we locked in a gain of nearly 2.5
points. The remaining shares of UTH short also stopped out in the morning, but
our profit from the first half of the position limited our loss on the trade to
less than 30 cents. We also bought a small position of BBH
(
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triggered at mid-day, but it reversed with the Nasdaq and is already near our
stop. Between the solid gain in RTH
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loss in BBH, yesterday was basically a scratch, but it surely would have been
worse if we were attempting to trade the broad-based ETFs as well. Novice
traders may sometimes get bored with our lack of new trade entries in
challenging market conditions, but part of being a professional trader and hedge
fund manager is knowing when to focus more on managing existing positions than
aggressively entering new ones. Being positioned mostly in cash the past few
days has undoubtedly saved us money!

Looking forward, the good news is that yesterday’s action
caused both the S&P and Dow to break out of their narrow and choppy ranges that
have plagued the market for the past week. Most notable is that the Dow cracked
below its range of the past several weeks and closed firmly below both its 50
and 200-day moving averages. Although it closed the previous day below its 50
and 200-day MAs as well, it was not until yesterday that the index fell below
support of its trading range. Because it is trading below its key moving
averages, the Dow does not have any major price support until it drops to its
prior lows near the 10,270 area. We have circled the next key area of price
support on the daily chart of the Dow below:

Prior support becomes the new resistance level after the
support is broken, which means that the 50 and 200-day moving averages will now
act as resistance on any rally attempt in the Dow. Shorting DIA (Dow Jones) over
the next few days is a safe bet if you keep your stop just above the 50 and
200-day MAs. The index may attempt to bounce a bit today, but it should not
exceed yesterday’s high.

Like the Dow, the S&P 500 also closed firmly below support of
its 50-day MA yesterday, but it also broke support of its primary uptrend from
the May low. As such, we are likely to see further downside on the S&P as well.
A short-term price target on the S&P would be the 1,190 to 1,195 area, which is
where the prior lows from late June and early July converge with the 200-day MA.
Conversely, the 50-day MA, along with the lows of the past week, should act as
overhead resistance from the 1,215 to 1,220 area. A bounce into that price range
would create a low-risk entry point to sell short SPY (between 121.80 to
122.15). The chart of the S&P 500 below illustrates yesterday’s break of the
primary uptrend line, as well as the next key area of support:

The Nasdaq Composite formed a bearish “inverted hammer”
candlestick yesterday, which was caused by the big rally in the morning and even
larger drop in the afternoon. This candlestick pattern usually leads to lower
prices in the short-term, which is even more likely considering that the Nasdaq
closed below its 50-day MA for the first time since May 13. The Nasdaq tested
support of its 50-day MA in the two prior days, but yesterday was the first time
it actually closed below it in three and a half months. However, despite
yesterday’s weakness, the Nasdaq continues to show relative strength to both the
S&P and Dow. As such, we would avoid shorting QQQQ or ONEQ because they would be
among the first of the broad-based ETFs to recover if buyers return to the
market. Next support on the Nasdaq Composite is the prior highs of June, near
the 2,100 area:

Finally, we want to bring your attention to the Broker-Dealer
industry sector
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the beginning of May through the middle of July, the $XBD index rallied steadily
higher, then began to consolidate in a sideways range. While a consolidation
near the highs is bullish and usually leads to new highs, a break below support
of that consolidation is equally bearish because it traps the longs who were
anticipating new highs. Furthermore, consolidations near the highs have a high
rate of failure during bearish market reversals, so they often present low-risk
short entry points after the consolidation has begun to fail. Yesterday’s
drop in the $XBD put the index below its prior low from August 18, which means
the sector may be poised for lower prices. There is still support of the 50-day
MA just below, but we wanted to give you an early heads-up to keep an eye on the
broker-dealer stocks for potential shorts. There is not an ETF that directly
tracks the broker-dealer index, but you can make your own “synthetic ETF” by
trading a small basket of stocks within the sector. Some of the big ones are:
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(
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Sheet). Interestingly, we also noticed that yesterday afternoon’s selloff in
the $XBD index coincided with the Dow dropping sharply below its 200-day MA.
Notice how the $XBD plummeted during the final hour of trading:

Because the 200-day moving average is generally viewed as a
gauge of the general public’s long-term sentiment, many traders and investors
fear that profits in the broker-dealer stocks will be directly harmed by the
resumption of the bear market that began in 2000. Of course, we never base our
trade ideas strictly on fundamentals, but it is an interesting theory to ponder
nevertheless.

Overall, our bias has now shifted from neutral to negative for
intermediate-term plays, particularly in the Dow-related sectors such as
Financial, Construction, and even Energy. We are also watching MDY
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for a potential short entry (subscribers can see details on the watchlist
below). You may also want to keep an eye on Biotechs to see how they hold up, as
that sector has been known to ignore broad market downtrends in the past. Techs
also still holding up okay. Yesterday’s selloff may not have been what you
wanted to see if you’re a bull, but the positive is that the market may now
break out of the choppy and erratic range of the past week. Any trend, either up
or down, is better than a narrow-range, sideways market.

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