Stalking a Short Position in the Retail Sector

The Nasdaq Composite posted its
fourth straight day of losses yesterday, while the more technology focused
Nasdaq 100 Index touched its 50-day moving average for the first time since the
current uptrend began in the middle of August. Stocks gapped modestly
higher on the open, trended lower throughout the late morning and mid-day, then
moved in a choppy, sideways range throughout the remainder of the session. The
Nasdaq Composite lost 0.5%, the S&P 500 slid 0.4%, and the Dow Jones Industrial
Average closed 0.3% lower. The S&P Midcap 400 declined 0.5%, while the small-cap
Russell 2000 gave up 0.3%. Each of the major indices finished above their lows,
but in the bottom third of their intraday trading ranges. It was the fourth time
in the past five sessions that the broad market settled the day near its
intraday low.

Total volume in the NYSE declined by 2%, while the Nasdaq’s
volume was on par with the previous day’s level. Despite each of the major
indices once again closing in the red, turnover remained subdued. The biggest
positive of the past week’s losses has been the lack of heavy institutional
selling. In both exchanges, only one of the past four “down” days have been on
higher volume. While the bulls may be taking a break for a while, the bears have
not yet demonstrated an extreme willingness to sell. Of course, it would not be
illogical for one to conclude that institutional traders are absent on both
sides of the market due to the holiday season. When volume returns after the new
year, we’ll get a clear idea as to which way the mutual funds, hedge funds,
pension funds, and other big players want to take the market. Until then, it’s
wise to take it easy with no trade entries, especially on the long side.

In the

December 13 issue of
The
Wagner Daily, we explained why we initiated a new short position in the
iShares DJ Transportation
(
IYT |
Quote |
Chart |
News |
PowerRating) the previous day. Specifically, we liked
that it had formed the right shoulder of a bearish “head
and shoulders” chart pattern, so we expected further downside. The IYT short
trade has followed through nicely since then, so we took profits by covering the
position for a 3-point gain yesterday. Although IYT is still slightly above our
original downside price target, we made a judgment call to lock in the gain
because it failed to bounce at support of its 200-day MA on the way down. This
tells us that it could easily snap back up to the 200-MA, or perhaps higher, if
the market bounces. An initial bounce and subsequent failure to hold above the
200-day MA a few days later would have increased the odds of further downside in
the short-term, but that wasn’t the case. Nevertheless, we netted a solid gain
on this setup:

One sector we are stalking for potential short entry is the
Retail Index ($RLX), which closed below support of its 50-day moving average for
the first time since August 30. More importantly, the break of the 50-day MA
followed a failed breakout to a new all-time high last week. Failed breakouts
out of a long base of consolidation are often among the most profitable short
setups because all the bulls who bought the breakout become trapped. Their
selling a few days later attracts the interest of the bears, who spotted the
failed breakout. That’s how the $RLX index went from a new record high down to
closing below its 50-day MA only four days later:

In the short-term, the $RLX index is a bit oversold and not
at an ideal entry point for a short sale. However, a bounce in the next day or
two would provide a positive risk/reward ratio for new trade entry on the short
side. The Retail HOLDR
(
RTH |
Quote |
Chart |
News |
PowerRating) is a very popular ETF for trading the sector,
but a list of other Retail ETFs can be found by downloading our free

Morpheus ETF Roundup
guide.

As for the broad market, it’s probably best to avoid entering
new positions today. With an extended holiday weekend coming up, volume is
likely to be very light today. When turnover dries up, erratic and whipsaw
conditions often occur. So, rather than looking for new trade entries, it’s best
to focus on managing existing positions and making a watchlist for potential
entries next week.

NOTE: The U.S. stock markets will be closed on Monday,
December 25, in observance of Christmas Day. The Wagner Daily will not be
published that day, but regular publication will resume on Tuesday. Have a great
holiday weekend with your friends and family!

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 .