Trade What You See, Not What You Think

Another capricious session caused stocks to
oscillate between positive and negative territory before finishing with mixed
results. Both the S&P 500 and Dow Jones Industrial
Average lost 0.1%, but the Nasdaq Composite gained 0.2%. The small-cap Russell
2000 also rallied 0.2%, while the S&P Midcap 400 similarly advanced 0.3%. As the
nearly unchanged closing prices indicate, the intraday action once again lacked
a solid sense of direction, making it challenging for many traders to remain
with short-term positions on either side of the market.

Total volume in the NYSE was 9% higher than the previous day’s
level, while volume in the Nasdaq increased by 13%. Although the Nasdaq rallied
on higher volume, it may be deceiving the label yesterday’s session as a bullish
“accumulation day” because the Nasdaq’s gain was primarily due to the
exceptional performance of one stock. The announcement of Apple Computer’s new
iPhone device sent shares of the heavily-weighted stock more than 8% higher
yesterday. Conversely, the narrow 0.1% loss in the S&P was not enough to declare
the NYSE as having a bearish “distribution day.” More accurately, the higher
turnover in both exchanges was indicative of “churning” that occurs when volume
surges higher, but prices are little changed. This bearish effect results from
institutional selling into strength and often precedes a substantial selloff
that occurs one or two days later.

If you’re a trend trader who has been actively trading the
markets over the past week, I’m confident you would agree that profiting from
either side of the market has been challenging. Since the new year began, there
has been a whole lot of intraday volatility, but little price movement by day’s
end. The S&P 500, for example, has whipped around in a 1.8% range over the past
five days, but is only showing a price movement of 0.4% (lower) since the start
of January. This erratic action has resulted in many traders getting stopped out
of both long and short positions, only to see their stocks and ETFs reverse in
the proper direction a few hours later. The directionless trading is made
apparent on the daily chart of the S&P 500. Looking at the chart below, notice
all the “wicks” or “tails” on the candlesticks of the past five days:

As you can see, the S&P 500 has experienced quite a bit of
intraday volatility, but has made little headway in either direction since the
new year began, especially within the last three days. The same could be said of
the other major indices as well. Check out the tight, sideways range in the
Nasdaq Composite:

The longer such a tight and narrow range continues, the more
significant the eventual range expansion will be. A quick glance at both charts
above illustrates the close proximity of both the S&P and Nasdaq to support of
their 50-day moving averages. The 50-day MA on the S&P is currently at the 1,401
level, while the Nasdaq’s 50-day MA is at 2,417. Also, notice how the two-day
low in the S&P and three-day low in the Nasdaq coincides with support of their
respective 50-day MAs. This convergence makes the 50-day MAs all the more
important. Don’t forget that both the market-leading Russell 2000 and S&P Midcap
400 indices have already broken their 50-day MAs.

We expect both the S&P and Nasdaq to make substantial,
momentum-driven moves over the next several days. A break of their 50-day MAs
(which converge with their January lows) would probably result in a rapid
downward thrust. On the other hand, an intraday probe below the 50-day MAs could
just as easily trigger a wave of institutional buying. Because of these indices
sitting at “make it or break it” levels, we continue to recommend caution and
reduced share size with all new positions. Now that earnings season is underway,
the reaction to the numerous corporate report cards will be the driving factor
that determines which direction the broad market goes. Be careful out there and
remember to always trade what you see, not what you
think!

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 .