Indecision Reigned Supreme Yesterday

Yesterday was a wild session filled
with volatile, whipsaw moves in both directions that left the major indices with
mixed results. The Nasdaq Composite, with a maximum intraday gain of
1.7% and loss of 0.9%, closed 0.3% higher. Both the S&P 500 and Dow Jones
Industrial Average were equally as indecisive, but closed with a loss of 0.1%
and a gain of 0.1% respectively. The small-cap Russell 2000 was unchanged, while
the S&P Midcap 400 Index advanced 0.4%. If you missed the intraday trading
action and only saw the final closing figures in the news, you might have
assumed yesterday was a relatively uneventful day, but it certainly wasn’t!
Instead, it was an erratic, high momentum tug-of-war between the bulls and
bears. Since each of the major indices finished in the bottom half of their
intraday ranges, the bears slightly had the upper hand in the end, but not
overwhelmingly.

As one might expect, the conclusion of the holiday season and
the four-day weekend caused volume to rocket higher across the board. In the
NYSE, total volume was a whopping 102% higher than last Friday’s level! Total
volume in the Nasdaq surged 88% higher. The NYSE saw its highest volume since
September 15, the “quadruple witching” options expiration day for the third
quarter of last year. Nasdaq volume was also way above average. The mixed
closing prices in the S&P and Nasdaq technically caused the former to
register a bearish “distribution day” and the latter a bullish “accumulation
day.” However, the extreme intraday volatility made it difficult to confirm
either scenario. In the morning, advancing volume in the Nasdaq exceeded
declining volume by a margin of more than 6 to 1, but the ratio was only
positive by less than 2 to 1 at the close. Conversely, the NYSE finished with a
negative volume spread of 1.2 to 1. Both institutional buying and
selling was at play throughout the day, but the trend of the market internals
indicated more overall selling than buying.

In yesterday’s newsletter, we noted how both the S&P and
Nasdaq were entering the new year at pivotal “make it or break it” levels.
Specifically, we mentioned that the stock market’s direction over the next month
would primarily depend on which scenario occurred first — a break below the
indices’ key support levels we illustrated or a breakout above equally important
resistance levels. To our surprise, the major indices did both yesterday! In the
S&P 500, we pointed out that the November 27 high of 1,427 was the resistance
level to watch, while the 20-day MA at 1,416, and especially the December 22 low
of 1,410, were key support levels. As you can see by the long “wicks” or “tails”
on yesterday’s candlestick, the range of the S&P exceeded both extremes
yesterday, but settled near the middle of its range:

In the Nasdaq Composite, we highlighted the December 29 high
of 2,437 as being a pivotal resistance level because a rally above that area
would also put the index back above its 20-day MA. Conversely, we anticipated a
break below support of the 50-day MA at the 2,410 area would lead to a rapid
break below the December 26 low. Like the S&P, the Nasdaq managed to trigger
both those support and resistance levels in yesterday’s session before
closing in “no man’s land.” Take a look:

Yesterday’s candlestick patterns in both the S&P and Nasdaq
consisted of a narrow body, but with long “wicks” or “tails” on both sides of
the body. This type of pattern is known as a “long-legged doji” candlestick and
it indicates the market was very indecisive. For this type of pattern to form,
the stock or index must have traded well above and below the opening
price level, but close the session near that opening price. Basically, the bulls
and bears battled it out, but no clear winner emerged in the end.

Commodities, especially crude oil, experienced significant
weakness yesterday. Spot gold dropped sharply, but our trailing stop strategy
still enabled us to lock in a gain of more than 1.5 points on our GLD
(
GLD |
Quote |
Chart |
News |
PowerRating)
position. We also registered a gain of nearly 3.5 points when the afternoon
slide in the Nasdaq 100 Index caused our long position in the UltraShort QQQ
ProShares
(
QID |
Quote |
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PowerRating) to hit its dividend-adjusted profit target. We still remain
long the UltraShort S&P Midcap ProShares
(
MZZ |
Quote |
Chart |
News |
PowerRating), which has been hovering near
the flat line since our entry point. We also bought a new position in the
UltraShort S&P 500 ProShares
(
SDS |
Quote |
Chart |
News |
PowerRating) when the S&P broke below its primary
uptrend line yesterday. The market’s recovery in the last hour of trading caused
SDS to move 50 cents against us, but we still like the trade as long as the S&P
does not break out above yesterday’s high.

Going into today, new support and resistance in the S&P and
Nasdaq will simply be equal to yesterday’s lows and highs in both indices.
Support for the S&P is at 1,407, while resistance of the high is at 1,429. For
the Nasdaq Composite, those levels are 2,394 and 2,454. As long as both indices
stay within those price ranges, be careful out there because it’s bound to be
choppy!

Fortunately, the type of trading action we experienced
yesterday is relatively uncommon, but the bad news is that such conditions can
result in rapid losses to your trading account if you lack discipline.
Obviously, nobody knows how long it will take for the market to resolve itself
in one direction or the other, so it is imperative that you take steps to
protect yourself from substantial losses in such a whippy environment. We
suggest reducing your share size on all new positions and also using mechanical
stop orders if you have trouble pulling the trigger and cutting your losses in
volatile markets.

Open ETF positions:

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 .