Here’s how Friday’s selloff was different

  • April 10, 2006
  • Deron Wagner

Stocks wrapped up the first week of the second quarter on a sour
note, as a broad-based selloff evaporated the broad market’s gains for the week. Last Friday morning’s opening strength quickly dissipated, causing the major indices to trend lower throughout the entire session. The S&P 500
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The sole positive buffer o the weak session was that the losses occurred on lighter volume. Total volume in the NYSE was 4% lighter than the previous day’s level, while turnover in the Nasdaq declined by 8%. This tells us that, although the market’s losses were substantial, institutions were not aggressively behind the selling. Had volume surged in conjunction with the selloff, the session would have borne much more significance. Nevertheless, market internals were firmly negative. In the NYSE, declining volume exceeded advancing volume by a margin of more than 5 to 1. The ratio in the Nasdaq was negative by approximately 7 to 2. 

One factor that differentiated Friday’s down day from other selloffs in recent weeks is that weakness was seen in every sector. Of the 24 industry sectors we follow on a daily basis, not a single one of them closed in positive territory. Even oil, metals, mining, and semiconductors, each of which have been showing relative strength lately, all closed in the red. The Biotech sector
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After closing above its 1,310 resistance level for only one day, the S&P 500 promptly reversed course and fell back into its choppy and erratic three-week trading range. This, of course, is bad news because the indecision of that trading range has caused a lot of failed breakouts and breakdowns over the past month. But the good news is that, dare I say, we may finally see some resolution and a confirmed break of the range. As we have mentioned before, we don’t care whether the break of the range is up or down, just as long as some sort of tradeable trend develops.

Although each of the S&P’s bearish reversal days in recent weeks failed to follow-through to the downside, one factor may yield a different result this time. That factor is that the S&P 500 closed below its 20-day moving average for the first time since the trading range developed. The index also is sitting just above support of its primary uptrend line, which has converged with support of the multi-week trading range. Because of this convergence, there is a very strong possibility that a break of that area of support would likely generate significant downward momentum. The red horizontal line on the daily chart below marks support of the trading range, which is only two points below last Friday’s close. The blue ascending line represents support of the uptrend line that has been in place since the low of October 2005. We have circled the convergence point:

It’s fair to say that all eyes will be watching to see how the S&P reacts as it tests key support at the 1,292 to 1,294 area. As for resistance on the upside, quite a bit of overhead supply has now been generated from traders who bought the trading range in anticipation of an eventual breakout.

This week kicks off quarterly earnings season, so be aware of when your positions are reporting their results. In the current environment, a greater than usual amount of volatility could result from earnings surprises. Perhaps the market’s reaction to the earnings reports of keystone companies will finally generate the impetus necessary to kick-start some type of confirmed trend in the broad market.

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Open ETF positions: 

Short (partial) BBH, long IGW (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 .