Want low-risk entries? Watch for entries in these 4 ETFs

Bearish momentum from Tuesday’s
losses accelerated Thursday, as stocks in
nearly every sector plummeted, causing extensive technical damage to the charts
of the major indices. The Nasdaq Composite
(
COMP |
Quote |
Chart |
News |
PowerRating) lost 1.7% and the S&P 500
(
SPX |
Quote |
Chart |
News |
PowerRating) dropped 1.5% yesterday, the biggest percentage losses in both indices
since April 15 of this year. The Dow Jones Industrial Average closed 1.2% lower.
Although those losses were quite substantial, they paled in comparison to the
wreckage in the small and midcap indices. The S&P Midcap 400 Index
(
MDY |
Quote |
Chart |
News |
PowerRating)
lost 2.3%, while the Russell 2000 Smallcap Index collapsed and registered a
whopping 2.9% loss! It was the largest single day loss in the Russell 2000
(
RUT |
Quote |
Chart |
News |
PowerRating)
since the index shed 3.8% on October 9, 2002. Interestingly, that day’s closing
price was also the lowest of the past seven years. Fortunately, our decision to
short IWM (Russell 2000 Smallcap Index) two days ago is now paying off nicely.
As of yesterday’s close, the trade is showing a marked to market gain of 2.33
points and is nearing our initial downside profit target.

Total market volume in the NYSE increased by 7% yesterday,
giving the S&P and Dow their third consecutive days of distribution and the
sixth within the past month. The Nasdaq managed to escape having another
“distribution day” thanks to a 2% decrease in volume. Nevertheless, market
internals were extremely bearish in both exchanges, particularly in the S&P and
Dow. In the NYSE, declining volume exceeded advancing volume by a staggering
ratio of more than 10 to 1! The Nasdaq’s ratio was negative by “only” 7 to 2.
Quite frankly, we don’t ever recall seeing declining volume outnumber advancing
volume by a ratio as high as we saw in the NYSE yesterday!

Over the past several days, we have noticed extreme weakness
in the formerly market leading sectors such as Oil, Utilities, REITs, and Home
Construction, each of which suffered quite sizable losses the past two days.
Every sector that rallies sharply for a multi-year period eventually sees its
peak and reverses. However, it is very risky to short these sectors without
first having confirmation that a top has formed. When the first major correction
comes in market leading sectors, corrections of at least 20% are common, but
timing is the key. Therefore, we will be stalking
(
OIH |
Quote |
Chart |
News |
PowerRating) (Oil Service HOLDR),
(
XLU |
Quote |
Chart |
News |
PowerRating) (S&P Utilities SPDR), and IYR/ICF (Real Estate Indexes) for low-risk
short entry points over the next several days. Each of those sectors have
already dropped sharply in the short-term, so we want to see at least a small
bounce or price consolidation before entering new short positions. On a side
note, the Home Construction Index ($DJUSHB), which we analyzed yesterday
morning, broke below support of its 200-day MA yesterday. As previously
discussed, we remain short a basket of home construction stocks within the
sector.

Taking an updated look at the major indices, you will see that
extensive technical damage has been caused by the selloff of the past two days.
Most notably, yesterday’s action caused the S&P 500 to close below support of
its 200-day moving average for the first time since May 13 of this year. It also
resulted in a break below support of the August low, as illustrated by the
horizontal dotted line on the chart below:

Similarly, the Dow Jones Industrial Average also closed below
support of its prior low from August, which it tested and initially bounced off
of on September 22. The Dow was already trading below its 200-day MA, but is now
well below it:

The Nasdaq Composite, which was showing relative strength
until yesterday, closed just a few points above the prior intraday low from
September 22, although it did break it on a closing price basis. The Nasdaq
still remains 26 points above its 200-day MA, the only one of the “big 3” broad
market indices still above it. Relative strength in a few of the tech sectors
have been helping the Nasdaq, so caution is required if shorting QQQQ. Other
broad market ETFs such as
(
SPY |
Quote |
Chart |
News |
PowerRating),
(
DIA |
Quote |
Chart |
News |
PowerRating),
(
MDY |
Quote |
Chart |
News |
PowerRating), or
(
IWM |
Quote |
Chart |
News |
PowerRating) are
probably safer bets on the short side. IWM, in particular, is very close to
breaking a big shelf of horizontal price support, so we intend to remain short
in anticipation of such.

It’s becoming quite obvious that the numerous sectors and
indices we pointed out and illustrated in the
October 4
issue of The Wagner Daily have resumed their downtrends after testing
resistance of their downtrend lines earlier in the week. Hopefully you have been
following our broad market and sector analysis of the past several days and are
profiting on the short side of the market. When most of the major indices and
industry sectors rallied into resistance of their daily downtrend lines over the
past week, it presented low-risk opportunities for selling short. Kudos to those
who saw the short setups and took advantage of them without hesitation.

If you are already short, there is no reason to take your
profits here, regardless of how tempting it may be. Instead, simply trail your
stops lower using a basic indicator such as the hourly downtrend lines or the
20-MA on the hourly charts. If, however, you are not yet positioned on the short
side of the market, realize there is a higher degree of risk to initiate new
positions here without waiting for at least a bounce into short-term resistance
or, at the very least, a few days of sideways consolidation near the lows. If
you’re still net long, be extremely careful regardless of which sector you are
in. If showing losses, be sure to honor your stops and don’t rationalize a
reason why you should disregard them. Taking small losses when you’re wrong is
more important than knowing how to pick winning stocks and ETFs. Above all,
remember to trade what you see, not what you think!

Open ETF positions: