Signs of a short-term market bottom

June 14, 2006
Deron Wagner

The Nasdaq’s fall to a
new low of the year on Monday triggered more downward momentum
yesterday, as the major indices suffered another round of losses on higher
volume. Small and mid-cap stocks, typically the best performers in bull markets,
again showed the most relative weakness. The Russell 2000 lost 1.5% and the S&P
Midcap 400 shed 1.6%. Major weakness in the gold and oil commodities weighed
heavily on the S&P 500
(
SPX |
Quote |
Chart |
News |
PowerRating), which dropped 1.0%. The Nasdaq Composite
(
COMP |
Quote |
Chart |
News |
PowerRating)
ost 0.9% and the Dow Jones Industrial Average
(
DJX |
Quote |
Chart |
News |
PowerRating) 0.8%. It was the
Nasdaq’s eight consecutive day of losses. Stocks attempted to recoup some of
their losses in the final hour of trading, but a round of selling in the final
fifteen minutes caused each of the major indices to close at their intraday
lows.

Turnover surged higher in both exchanges,
registering just below the huge volume levels of June 8. Total volume in the
Nasdaq swelled by 32% to more than 2.5 billion shares, while volume in the NYSE
jumped 42% above the previous day’s level. Obviously, it was another day of
confirmed institutional distribution. Counting the number of “distribution days”
while in a bull market is useful at predicting market tops, but keeping track of
the count is less important when the markets are in a confirmed downtrend. A
vast majority of the “down” days since the selloff began on May 10 have been on
higher volume. Higher volume has been present on several of the “up” days during
that period, but the number of “down” days has far exceeded the quantity of
“down” days. Further, the percentage gains on the winning days have been minimal
compared to the losses on the losing days. Market internals remained quite
negative yesterday as well. In the NYSE, declining volume exceeded advancing
volume by more than 5 to 1, while declining volume in the Nasdaq was heavier
than advancing volume by 3 to 1.

Eventually, the markets will form at least a
short-term bottom, which should generate some upward momentum from short
covering and bargain hunting. But the big question, of course, is when exactly
that will occur. While we are not in the business of predicting exact dates for
such things, we can at least analyze various technical factors and indicators
that are occurring right now. For starters, there needs to be some sort of high
volume capitulation resulting from fear. The monstrous volume and intraday
reversal on June 8 initially appeared as if it may have been the ticket, but
Monday’s new low in the Nasdaq invalidated that notion. To complement the
Nasdaq’s new low, both the S&P and Dow also fell below their June 8 lows
yesterday as well. The Dow’s 0.8% loss has now caused all three of the major
indices to move into negative territory for the year. The one positive is that
market internals have been extremely negative over the past several days, but it
seems as though we have yet to see final price capitulation that is necessary
to form a market bottom.

Another indicator we look for when trying to
detect market bottoms is a complete breakdown of former market leading stocks
and sectors. Prior to this week, a vast majority of high flying stocks and
industry sectors had begun to fall apart, but it is only within the past two
days that the last of the leaders have begun to fall sharply. Of the
approximately 1,800 stocks in the U.S. markets that trade an average daily
volume of at least 300,000 shares and are priced higher than $10 per share,
there were 11 stocks that gained at least 300% in price from May 31, 2005
through May 31, 2006. Each of these stocks showed great relative strength by
holding near their highs throughout the first four weeks of the broad market
selloff, but they have all begun to come unglued. InfoSonics Corp.
(
IFO |
Quote |
Chart |
News |
PowerRating)) was the
top gainer, having gained 780% during that period, but it has dropped an
astonishing 56% throughout the past seven sessions! Hansen Natural
(
HANS |
Quote |
Chart |
News |
PowerRating) and NutriSystem Inc.
(
NTRI |
Quote |
Chart |
News |
PowerRating), which gained 396% and 454% respectively, have both
sliced below support of their 50-day moving averages, but only within the past
two days. While it is painful for those who bought near the highs and didn’t cut
their losses quickly, it is actually positive to see the last of the market
leaders finally begin to fall apart. A complete washout of the high flyers helps
the market to catch its breath over the long-term and enables new companies with
strong earnings growth to stick their heads above water and eventually become
the new leaders. When we start to see such stocks breaking out of sound bases to
new highs, it will be a very positive sign that the worst may be behind us. That
hasn’t happened yet, but at least the remaining high flyers are now correcting.

In addition to breakdowns in former market
leading stocks, we are now seeing similar action in the industry sectors that
were formerly leading the market. Prior to the selloff, the strongest sectors of
the preceding twelve months were Oil, Metals Mining, and Gold. All three of
those sectors have fallen apart over the past several weeks. The Oil Service
HOLDR
(
OIH |
Quote |
Chart |
News |
PowerRating), a popular ETF that mirrors the Oil Service Index, closed
yesterday below support of its 200-day moving average for the first time since
December of 2003. When OIH recovered back above its 50-day moving average in the
beginning of June, it appeared as if it had the potential to make another run at
a new high. However, institutions promptly sold into strength, causing OIH to
form a significant “lower high” and collapse below its May low:

As you can see, OIH is now officially dead and
can be sold short into any decent retracement. The StreetTRACKS Gold Trust
(
GLD |
Quote |
Chart |
News |
PowerRating)
has similarly plummeted below support of its primary uptrend line, although it
is still above its 200-day moving average. We recently mentioned GLD was sitting
at pivotal “make it or break it” support of its 50-day moving average and it has
obviously chosen to “break it” rather than “make it.”

With all of the former market leading
stocks and sectors now breaking down, the market may soon find some equilibrium,
but it is very risky and foolish to call a market bottom without first getting
some type of clear signal. We covered our remaining shares of the Dow Jones
DIAMONDS
(
DIA |
Quote |
Chart |
News |
PowerRating) for nearly a four-point gain yesterday because it dropped to
support of its January 2006 low, the area of our original downside price target.
However, this does not mean we have turned bullish on the markets.
Rather, we are simply taking a more neutral stance in the short-term and backing
off on new short entries. After netting substantial profits on numerous short
positions in the MTG Stalk
Sheet, we are content to be positioned mostly in cash. New short setups
offering a good risk/reward ratio are presently difficult to find because so
many stocks and ETFs have already fallen substantially. Further, reversal! s
from sharp downtrends often occur rapidly and without warning, so we’re not
interested in being overly greedy on the short side right now. Patient and
disciplined traders are always rewarded in the long-term, even if an opportunity
is missed along the way.

Open ETF positions:

Long TLT (regular subscribers to

The Wagner Daily receive detailed stop and target prices on open
positions and detailed setup information on new ETF trade entry prices. Intraday
e-mail alerts are also sent as needed.)

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.

Signs of a short-term market bottom

BUY THE FEAR, SELL THE GREED

Quick Links

Company Info

Contact

Company Resources