Market health watch

January 18, 2006
Deron Wagner

The broad market resumed its corrective action that began on January 12, as the S&P and Nasdaq both closed lower on increasing volume yesterday. After beginning the day with an opening gap down, the major indices trended modestly lower throughout the morning session, attempted to recover in the afternoon, but still finished below their morning highs. Weakness in the Semiconductor and related technology sectors weighed on the Nasdaq Composite and small-cap Russell 2000 indices, which fell 0.6% and 0.7% respectively. Both the S&P 500 and mid-cap S&P 400 shed 0.4%, while the Dow Jones Industrial Average lost 0.6%.

Total volume in the NYSE increased by 4% yesterday, while volume in the Nasdaq was 1% higher than the previous day’s level. The increase in overall turnover, combined with the broad-based market losses, caused yesterday to become the first bearish “distribution day” of the new year. It was the first sign of institutional selling the market has seen since the current uptrend began on January 3. Market internals were bearish, but not overly so. Declining volume exceeded advancing volume in both exchanges by a margin of only 2 to 1.

After the close of trading yesterday, tech heavyweights Intel, Yahoo!, and IBM each released the results of their quarterly earnings. It wasn’t pretty. Although each of those companies usually meet or exceed their earnings expectations every quarter, all three of them fell short of their profit and/or revenue expectations. Both Intel and Yahoo! missed their EPS and revenue expectations! IBM exceeded its earnings expectation, but the revenue number fell short. Needless to say, the combination of these negative reports took investors and traders by surprise, which resulted in sharply lower prices in the after-hours market. Both Intel and Yahoo! were trading more than 10% lower by the conclusion of after-hours trading, while IBM was off slightly.

As one might expect, the less than impressive earnings reports after the close also triggered a sharp slide in the overnight futures markets. As of the time of this writing, the Nasdaq futures are trading 1.9% below yesterday’s close, while the S&P futures are off 0.9%. Hopefully you heeded our advice in yesterday’s Wagner Daily to steer clear of the Semiconductor sector and to reduce your position size in any new positions you may have entered ahead of last night’s earnings reports. With both Apple Computer and eBay reporting earnings after today’s close, you may want to completely avoid entering new positions today as well.

Today’s anticipated opening gap down in the market could hurt traders in the short-term, but the positive is that we will soon see how healthy the market really is under the surface. Over the past few days, we have been talking about how both the S&P and Nasdaq should find support at their prior highs from December. The 20-day moving averages, which have converged with those prior highs in most cases, should provide further support. The major indices will most likely test these support levels today, so we will be paying close attention to how traders react when that occurs. The bullish scenario would be for traders to buy the opening weakness and corresponding gap down to support, followed by an intraday trend reversal and closing prices near unchanged or better. Conversely, today’s opening losses could snowball and become quite substantial if the indices fail to promptly bounce off their key support levels. If traders fail to see accumulation or buying pressure near the support levels, this in turn could trigger a bit of “panic selling.” Just to quickly review, the key support levels on both the S&P and Nasdaq are represented by the blue horizontal lines on the charts below:

As you know, we have been looking forward to a price correction down to the indices’ key support levels so that we can enter new long positions with minimal risk, BUT we never advocate naively anticipating a short-term bottom without seeing confirmation of the trend reversal first. In other words, it is risky to blindly buy weakness today simply because the market is near key support levels. Instead, we prefer to wait for the first breakout above the hourly downtrend lines that will have formed. When an uptrending index falls to support on its daily chart, the first subsequent rally above the 60-minute downtrend line usually presents the most ideal long entry point. We, of course, will be watching for these potential entry points and will promptly inform regular subscribers of any new long entries via intraday e-mail alerts.

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 .

Market health watch

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