Broad Market Analysis - Don't forget risk/reward in your trading!
The Nasdaq Composite kicked off the holiday-shortened week with a higher volume session of gains that pushed the index to a new six-year high. The first forty-five minutes of trading were looking pretty bleak, as the Nasdaq had fallen below support of its short-term consolidation and was showing a 0.7% loss. But the bulls reversed the situation, promptly erasing the loss and eventually sending the Nasdaq to a 0.7% closing gain. The S&P Midcap 400 also gained 0.7%, but less enthusiasm was found in the S&P 500 and Dow Jones Industrial Average, which closed higher by 0.3% and 0.2% respectively. The small-cap Russell 2000 turned in the best performance with a 1.0% advance.
Turnover in the NYSE declined by 3% yesterday, but total volume in the Nasdaq surged 15% above the previous day's level. The solid gain on firmly higher volume enabled the Nasdaq to register its second "accumulation day" within the past five sessions. Strong market internals also confirmed the institutional buying. Advancing volume in the Nasdaq exceeded declining volume by a margin of 3.5 to 1. The NYSE ratio was positive by only 3 to 2.
Yesterday, all but one of the major indices closed at a new high. The S&P 500 and Nasdaq Composite both finished at six-year highs, while the Dow, S&P Midcap, and Russell 2000 indices all finished at record highs. Only the tech-concentrated Nasdaq-100 Index remains in a range. Because most of the indices were already trading at their highs, the new highs they set yesterday were not very surprising. Even the Dow's modest 0.2% gain, for example, was enough to send the index to another all-time high. It was significant, however, that the Nasdaq Composite finally cleared resistance just over the 2,500 level. Last week, the Nasdaq was in the process of completing the right shoulder of a bearish "head and shoulders" chart pattern, but the rally over the top of the "head" (the high of January 16) has invalidated the pattern:
With the S&P, Nasdaq, and Dow all trading at new highs, there is literally a complete lack of overhead supply and price resistance. Stocks and indexes trading at 52-week highs can move higher with minimal buying pressure because there is simply an absence of investors and traders who are selling into strength "just to break even." Remember that supply and demand, pure and simple, moves the markets. Nevertheless, astute traders must continually assess the overall risk/reward of entering new positions.
In case you are not familiar with the term, "risk/reward" is a measure of the amount of risk a trade setup incurs, compared the potential profit (reward) if the trade goes as planned. For every trade we enter, we require a risk/reward of at least 1 to 2. If, for example, we are buying an ETF that requires a protective stop 2 points away from the current price, the realistic price target must be at least 4 points away from the current price. It it is, then our risk/reward ratio on the trade setup would be 1 to 2. Trade setups with a ratio of 1 to 3 or better are prized. The higher the risk/reward ratio, the more times you can stop out of a trade and still be net profitable at the end of the month. Conversely, taking setups with a low risk/reward ratio of 1 to 1 requires a much higher rate of accuracy.
With no overhead resistance levels to speak of, the short-term odds obviously favor the long side of the S&P, Nasdaq, and Dow. However, we must be cognizant of the actual risk/reward of the broad market at current levels. With the S&P and Dow both trading well above the upper channel of their long-term uptrends and the indices working on nine consecutive months of gains, we can't help but wonder how much more upside remains (reward) compared the amount of downside (risk) when the inevitable correction sets in.
Looking at the weekly charts, a correction in the S&P 500 just down to the upper channel of its long-term uptrend would put the index around the 1,400 level. A 50% Fibonacci retracement from its July 2006 low up to its current high would put the S&P around the 1,342 level:
A sell-off down to the 1,400 level would represent a 4% drop from its current price, while a 50% Fibonacci retracement would be an 8% drop. What is the likelihood of the S&P rallying 8% to 16% more without a correction? Unless you trade only short-term momentum and are nimble/willing enough to close positions immediately after entering them, it seems we are clearly facing a negative risk/reward ratio on all new long entries. Unfortunately, the situation in the Dow is very similar, but the Nasdaq could be the saving grace. Since it just broke out to a new high after three months of sideways consolidation, the overall risk/reward in the Nasdaq is better.
If you're one of the aforementioned short-term momentum traders, go ahead and keep playing the odds on the long side of the market. Otherwise, please tread very lightly at current levels, keeping a healthy percentage of cash in your portfolio. Yesterday, we listed four different sector ETFs we were watching for potential entry. We bought the PowerShares Clean Energy (PBW) when it broke out above resistance, but we will be managing it carefully. Over the years, we have learned that consistently profitable traders are continually rewarded for patience and discipline.
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In this column, MTG presents you with a FREE, actual trade setup that we are stalking for entry at some point during the week. Note that, unlike the daily guidance that regular Stalk Sheet subscribers receive, this free Stalk of the Week does not take into account overall broad market conditions that can easily affect the trade over the next several days. This week's setup is:
Click to receive your free 1-month trial to The MTG Stalk Sheet so that you can receive an average of one to three trade ideas such as this one on a daily basis (limit one free trial per household). Subscribers are always provided with detailed entry, stop, and target prices for each trade, and intraday e-mail alerts are sent as needed.
Below is the weekly commentary that accompanied this week's updated ETF Trend Tracker that was e-mailed to subscribers at the beginning of the week. The Morpheus ETF Trend Tracker, a perfect supplement to the ETF Roundup guide, is a comprehensive table of Exchange Traded Funds (ETFs) designed for informed investors and longer-term traders who prefer to hold their ETF positions for a few weeks to several months at a time. Based exclusively on a weekly analysis of trendlines on the daily and weekly charts, the ETF Trend Tracker provides subscribers with a thorough snapshot of the primary trend direction of ETFs in every category from broad-based to industry sector to international. This information is e-mailed to subscribers weekly, in a user-friendly format that groups ETFs based on the direction of their primary trends.
Commentary:The bulls remained in control through the end of the week, causing the major indices to finish near their highs. Numerous "swing low" support levels were formed in the process, where you will see many ETF stops have been raised to. Precision stop placement by the professional MTG analyst team is the key to limiting your risk and maximizing your profits. Please review the latest ETF Trend Tracker report, along with the freshly annotated charts, and you'll see what we mean. Each price level and chart has been individually reviewed and commented. These stop levels are not generated from phony artificial intelligence software, but from experienced traders who manage real capital. The entry triggers and stop prices are exactly what traders with sizable accounts and positions want to see and use, as long as they are willing to trade within the report's dynamic time frame.
The market continues to show an overall bias to the upside, but we are stalking for ETFs that are showing relative weakness and setting up for trend reversals. When the broad market inevitably corrects, these ETFs will offer the best profit potential on the downside. Although the recent choppiness initially caught us on the wrong side of the trend, the majority of the ETF tickers have more than made up for the misgivings. If those positions were entered on the long side when they began to hit their reversal triggers, most of the previous losses would have been eliminated.
Real Estate (IYR) has stabilized after hitting our stop, but we made a sizable 24% gain on the partial exit. Internets (HHH) picked up momentum last week, and we are monitoring this one for new highs. The Dow Transportation (IYT) ended the week near its high and is showing a lot of relative strength. Since so many other ETFs are turning in strong performances, it is easier to tell you which ones are not. Semis (SMH), Software (SWH), and Wireless (WMH) are all very indecisive. Even though WMH just entered into the "ascending trend," we don't like its choppy nature relative to its price range over the last few months. If you want to participate and invest in any of the ascending ETFs mid-trend, we suggest using the MTG Stop (S1) as your initial risk level. Write these price levels down, set alerts, or place actual sell stops after making your long entries.
Our stops for the fixed-income (bond) ETFs are tight, and they too may move to the ascending trend this week. But looking at the price ranges, their moves are not significant. Once they trigger, it is just affirmation that it is okay to accumulate bonds again.
The majority of the international ETFs moved higher for the week. Lagging behind were China (FXI), Hong Kong (EWH), and United Kingdom (EWU). FXI is forming a "symmetrical triangle" pattern, and is poised to make a sharp move in one direction or the other.
In the Specialty sectors, the IPOs (FPX) formed a swing low, so its stops have been moved higher to lock in a 20% gain since mid-September of 2006. The Euro Currency (FXE) is very choppy, but is once again on the "ascending trend" list. Oil (USO) has leveled out and is now consolidating.
Alerts of imminent reversal to the upside:Click to receive your free 1-month trial to the ETF Trend Tracker (limit one free trial per household), which will be e-mailed to you every week, along with intra-week updates on an as-needed basis.