How to determine your target price

After beginning the day with an
opening gap higher, the bears attacked again and sent stocks lower,
but a solid reversal in the final ninety minutes of trading pushed stocks back
into positive territory. Small caps rebounded nicely, as the Russell 2000 Index
turned an intraday loss of 1.0% into a closing gain of 0.6%. The Nasdaq
Composite similarly showed a loss of 1.2% at its worst level, but finished with
a 0.3% gain. The S&P 500 advanced 0.2% and the Dow Jones Industrial Average
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rallied 0.5%, but the S&P Midcap 400 continued to show relative weakness and
gained less than 0.1%. The intraday price pattern of the broad market was
indicative of a bullish reversal day that often occurs after an extended
downtrend.

Confirming yesterday’s bullish price pattern was a healthy
rise in turnover across the board. Total volume in the Nasdaq
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32% higher, while volume in the NYSE was 18% higher than the previous day’s
level. The broad market’s gains on higher volume means yesterday was an
“accumulation day” that signaled institutional buying. When this occurs in
combination with the type of intraday reversal patterns that we saw yesterday,
it usually leads to further upside momentum, at least in the short-term. Stocks
collapsed immediately after the S&P 500
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day” on July 11. When the market is very weak, “accumulation days” that occur
after stocks have bounced off their lows are often the result of
institutional selling into strength rather than buying interest. But yesterday’s
high volume gains occurred at the bottom of an extended downward move, which
represents institutional buying into weakness as opposed to selling into
strength. Market internals finished positive, but not by a wide margin.
Nevertheless, the advancing/declining volume ratios recovered from the rather
negative levels that were present at mid-day.

Yesterday morning’s weakness caused our short position in the
S&P Midcap SPDR
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covered the remaining shares for a gain of more than 7 points. Within one hour
of trading down to our target price, MDY began to reverse with the broad market
and actually closed nearly 1.5 points higher than where we covered the position.
One subscriber subsequently e-mailed us, asking how we originally determined an
accurate downside price target on the trade setup. Rather than e-mailing that
person a direct response, we thought the subject would be an interesting
educational blurb to cover in today’s Wagner Daily. The daily chart below
illustrates our entry and exit points on the trade, while the commentary that
follows explains the original premise of the setup:

We originally sold short MDY on July 7, then subsequently
added 50% more shares on July 10, giving us an average price of 137.69 on the
full position. At the time of the initial entry, the broad market had begun to
show signs that its prior rally was running out of gas. The key signal was the
relative weakness in the Semiconductor Index ($SOX), which had already fallen
below its prior low from June and was dragging down the Nasdaq. Further,
breakouts began failing again and overall volume was increasing near the highs.
This combination of factors told us it was time to re-short one of the
broad-based ETFs into the bounce off the June lows. To determine which one, we
simply looked at relative weakness and determined that MDY was lagging the most
on the way back up and dropping the most on the down days. The specific impetus
that caused us to sell short on July 7 was that MDY had dropped back down to its
200-day moving average (the orange line), after being unable to rally above its
50-day MA (the teal line). We anticipated that MDY would fall apart quickly if
the broad market weakness continued because it had already dropped back down to
its 200-MA. However, we wanted confirmation that it would not probe below the
200-MA and reverse sharply higher the next day. On the morning of July 10, MDY
briefly attempted to rally, but it sold off again and closed below its
200-day MA. This gave us the confirmation we were looking for, so we added to
the position at that point.

The initial protective stop price of MDY was 140.39. We
determined this price by simply placing the stop above resistance of the 50-day
moving average. Since the 50-MA previously stopped the rally on July 3, a second
attempt to break through the 50-MA that succeeded would likely lead to much
higher prices. Therefore, we wanted to be out quickly if the 50-MA was violated.
Fortunately, that never happened. As MDY began to drop in the days that
followed, we trailed our stop lower to maximize the gains while protecting the
profits. A variety of factors were used to determine where to trail the stop,
but resistance of the hourly downtrend line was used as a basis.

Getting back to the original question from our subscriber. .
.How did we determine the target price? For trades with an average hold time of
several days to a few weeks, we find that keeping it simple and focusing on the
last significant low tends to provide support (or the last significant high if
you are going long). At the time of our entry, the last significant low that was
set before MDY rallied was the June 14 low of 130.31. If MDY began dropping
hard, that was an area that had very good odds of generating a reversal of
momentum. MDY worked out to be a textbook-like example, as it touched its prior
significant low yesterday and reversed right at support of that level. This, of
course, does not mean that MDY will not go lower, but it served as the ideal
place to cover your short position if you were not willing to hold through a
potential retracement in the opposite direction.

In yesterday’s session, three of the five major indices we
follow touched support of their prior lows before reversing: the S&P Midcap 400,
the small-cap Russell 200, and the Dow Jones Industrial Average. The S&P 500
still remains above its prior low from June, while the Nasdaq has been trading
below it for some time. Based on yesterday’s bullish reversal action, we are
likely to see at least a few days of price gains in the broad market from here.
It’s too early to speculate how long the bounce will last, but caution on the
short side is definitely in order here. Keep those stops tight to prevent any
short positions from quickly rallying back to your initial entry points.
Conversely, there is no reason to go long and buy ETFs either, but that time may
come if stocks begin breaking their hourly downtrend lines. As always, we’ll
keep you abreast of anything that looks good for potential buys. Remember that
earnings season tends to affect technical patterns as well. Yahoo!
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reported earnings after yesterday’s close and had a negative impact on the
Nasdaq futures in the after-hours, so we’ll see whether or not the market shakes
off the overnight weakness. We like being in cash right now, ready to pounce on
either side of the market, but without the risk of getting caught on the wrong
side.

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