Here’s The One Positive Note I See

August 5, 2005
Deron Wagner

Nearly every industry sector closed lower yesterday, but a gain of 0.6% made
the Oil Service Index
(
OSX |
Quote |
Chart |
News |
PowerRating) the exception. Retail stocks dropped sharply and
many of them broke their primary uptrend lines. As such, we have listed RTH
(
RTH |
Quote |
Chart |
News |
PowerRating)
as a potential short candidate on “Today’s Watchlist” below. The Semiconductor
Index
(
SOX |
Quote |
Chart |
News |
PowerRating) also gave up 2.4% yesterday, but that’s not too bad considering
the index has rallied 16% since July 1. The drop in the SOX caused half of our
SMH position to hit its trailing stop at $37.70, enabling us to lock in a gain
of more than 8%. We still remain long the second half of the position. The Gold
and Silver Index
(
XAU |
Quote |
Chart |
News |
PowerRating), which broke out above resistance the previous day,
initially traded higher yesterday morning, but drifted lower and closed near the
prior day’s high and unchanged. We continue to like this sector for new
intermediate-term long entries (reference yesterday’s Wagner Daily for a
list of potential gold/silver plays).

Although the losses in the major indices were substantial, the one positive
is that volume in both exchanges did not correspondingly surge higher
with the selling. Total volume in the Nasdaq declined by 10%, while volume in
the NYSE was 2% lighter than the previous day. One could argue that market
volume has been lighter due to the “summer doldrums” in which traders are away
on vacations. This may be true, but the fact still remains that higher volume on
the up days combined with lower volume on the down days is bullish, even if the
overall volume levels are mostly below average. Within the past four weeks, both
the S&P 500 and Nasdaq Composite have only seen one confirmed day of higher
volume selling (“distribution”). A majority of the “up” days during that period
have also been on higher volume, which continues to indicate institutional
accumulation. While yesterday’s losses raise a yellow flag in the short-term,
our overall bias will remain bullish unless we begin to see “distribution
days” that typically indicate institutional selling.

Looking at the broad market, yesterday was the first day in more than a month
that each of the major indices closed firmly below support of the 50-period
moving averages on their hourly (60-minute) charts. Correspondingly, the S&P,
Nasdaq, and Dow also broke below support of their hourly uptrend lines that had
been in place since the middle of July. The hourly chart of the S&P 500 below
illustrates this:

While a one-day closing price below the hourly uptrend line does not mean the
primary uptrend has been broken, it does provide us with our first reason to be
cautious on the long side of the market since the current rally began on July 7.
At the least, odds are good that the broad market will experience a short-term
correction of 2 to 5 days. As such, we do not recommend aggressively entering
new long positions until we see if yesterday’s action was merely a shakeout or
the beginning of a more substantial correction. Instead, focus on managing
existing long positions and trailing stops appropriately. If you are in stocks
or ETFs that are near key areas of price support, such as moving averages,
trendlines, or prior highs, consider raising your stop to just below those
levels in order to protect your gains and/or minimize your losses in the event
of further selling.

Just as now is not the ideal time to enter new long positions, it is equally
risky to enter a bunch of short positions at the first hint of trouble. But it
is a good idea to begin preparing a list of potential short candidates so
you are prepared if the opportunity for shorting presents itself. We feel the
best scenario for shorting the broad-based ETFs would occur if the major indices
break through support of their 20-day moving averages, then subsequently bounce
into resistance of those same moving averages. Waiting for the first clear break
of support and then shorting the next bounce is infinitely safer than trying to
pick tops of a rally.

The market will surely tell us which side to be positioned on over the next
several weeks, but patience is crucial right now. Novice traders often give back
profits they made in uptrends by overtrading during transitional periods in the
markets. Remember that cash is always king and there are always plenty of new
opportunities if you happen to miss one. Most importantly, always trade what
you see, not what you think!

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.

Regular monthly subscribers to
The Wagner Daily receive
detailed setups of ETF trades, including trigger, stop, and target prices, as
well as intraday e-mail alerts. 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 .

Here’s The One Positive Note I See

BUY THE FEAR, SELL THE GREED

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