How to spot a failed intraday breakout attempt

Seat belts were required in
Wednesday’s session, as the intraday market action was a wild roller
coaster ride. Initially blowing off the previous day’s post-Fed weakness, and
aided by a positive earnings report from tech giant Cisco Systems, the Nasdaq
Composite
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faded promptly, causing the market to drift lower throughout the first ninety
minutes of trading, but a wave of buying in the mid-day doldrums launched the
Nasdaq to a new high of the day. Just when the bulls began to get comfortable,
the bears took control in the afternoon, sending stocks to new intraday lows. By
day’s end, each of the major indices had given back sizeable gains and finished
at their worst levels of the day. The Nasdaq closed only 0.1% lower, but it was
quite bearish that the index surrendered its early 1.8% gain. The S&P 500
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similarly turned a 1.0% intraday gain into a 0.4% closing loss. Blue chips
showed relative weakness for a change, as the Dow Jones Industrial Average
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fell 0.9%. The small-cap Russell 2000 also slid 0.9%, while the S&P Midcap 400
lost 0.7%. Separately, the price of spot silver continued its steady ascent,
pushing the iShares Silver Trust
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long position in SLV is showing a marked-to-market gain of more than 10 points,
but it has not yet hit our price target. We will continue trailing a stop
tighter as it moves further into the money.

Higher volume in both exchanges caused both the S&P and Nasdaq
to sustain its second consecutive "distribution day." Total volume in the NYSE
rose by 5%, while volume in the Nasdaq was 10% higher than the previous day’s
level. Although the actual percentage loss in the Nasdaq was minimal, the
session was definitely driven by institutional selling because the index
plummeted nearly 2% in the afternoon and closed at its low. In the NYSE,
declining volume exceeded advancing volume by a ratio of 2 to 1, but advancing
volume eked out a marginal lead over declining volume in the Nasdaq.

Just as we often see morning downtrends reverse into afternoon
uptrends in strong markets, it is equally common for the market to surrender
intraday gains in weak markets. If you check out a daily candlestick chart of
the S&P 500, you will notice "wicks" or "tails" above the bodies of many candles
over the past week. Each one of those candlestick formations indicates a failed
intraday breakout attempt. As anticipated, the S&P 500 also broke down below its
200-day moving average yesterday, benefitting our long position in the
UltraShort S&P 500 ProShares (SDS). The S&P still has support of both its 20 and
50-day moving averages below, but the break of the 200-MA, combined with the
recent failed breakout attempts, is probably more significant. Although it still
has a long way to go, we feel the odds are increasingly good that the S&P 500
will soon re-test its prior low from July 18. If it does, beware of a potential
breakdown to a new low because it will be the third test of support at the 1,220
to 1,225 area. The failed breakout attempts in the S&P are highlighted on the
chart below:

Since it has been showing relative weakness to the broad
market nearly every day, the Russell 2000 Index is much closer to breaking its
July low than the S&P 500. As you may recall, we initially sold short the
iShares Russell 2000
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a bearish "head and shoulders" formation on its daily chart. It subsequently
attempted to break out above its 200-day MA on August 4, but the breakout failed
and IWM missed our stop by less than a nickel. We still remain short IWM, which
is now only than 1.4 points above its prior low. If the broad market weakness
continues, the Russell 2000 should be the first index to fall below its prior
low from July. The daily chart of IWM below shows how it has started to roll
over and is rapidly nearing its prior low.

In recent weeks, the Dow was one of the few indices holding
the market up. But now the Dow has also begun to show relative weakness, making
a short sale in the DIAMONDS
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so, however, we would first want to see the Dow fall back below its 200-day MA
at the 11,000 level. The $SOX broke out above its three-month downtrend line on
August 3, but has gone absolutely nowhere since then. The index tried to get a
rally going on August 4 and 9, but failed to hold its gains both times. If the
Dow has started to roll over and the $SOX keeps failing its breakout attempts,
we must ask the question, "What will save the market from testing and perhaps
breaking below its prior lows?" The trend is your friend, and the simple
fact is the major indices remain in their downtrends that started in mid-May.

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