Broad Market Analysis - Short-term resistance levels on the S&P and Nasdaq
Stocks attempted to kick off the week on a positive note by erasing some of last week's losses, but the sellers won the choppy session by day's end. After gapping lower on the open, the broad market briefly moved into the black several hour later, but an erratic tug-of-war between the bulls and bears led to indecision in the afternoon. A wave of selling during the final hour eventually caused the major indices to close at their intraday lows. Like the previous day, small and mid-cap stocks led the market lower. The Russell 2000 Index plummeted 2.0%, while the S&P Midcap 400 lost 1.8%. The Nasdaq Composite, up 0.4% at its morning high, finished 1.2% lower. The S&P 500 and Dow Jones Industrial Average were lower by 0.9% and 0.5% respectively.
Total volume in the NYSE was 7% higher than the previous day's level, as volume in the Nasdaq tapered off by 3%. The loss on higher volume in the S&P (aka "distribution day") indicates that institutional selling remains in effect, though the Nasdaq's losses of the past two days have been on lighter volume. Still, market internals were rather bearish. Declining volume in the NYSE blew away advancing volume by a margin of 10 to 1. The Nasdaq ratio was negative by 9 to 2. When the market is in an uptrend, we maintain a rolling count of how many "distribution days" the S&P and Nasdaq sustain within a one-month period because doing so enables us to have an early warning of potential market tops. However, keeping track of "distribution days" serves less purpose when the market is already in a corrective mode. Instead, we're on the lookout for signs of institutional accumulation that may signal at least a short-term bottom. This would occur if the S&P and/or Nasdaq make a solid advance on higher turnover.
Over the last five days, the Nasdaq Composite has tumbled 6.5%, the S&P 500 has swooned 5.2%, and the Dow Jones Industrial Average has fallen 4.6%. In last week's newsletter, we illustrated how the S&P has a lot further to fall before finding long-term support, but on a short-term basis, one could reasonably conclude that the market is "oversold" and is likely to bounce within the next several days. In case that happens today, let's take a look at where the S&P and Nasdaq are likely to run into overhead resistance levels. With the major indices quite far away from resistance on their daily charts, we will drill down to the shorter-term hourly chart interval. Normally, we would simply look at resistance of the hourly trendlines, but the downtrends has been so strong that any small bounce in the market will cause a break of the current trendlines. Therefore, our most effective tool for predicting support and resistance levels in strong trends is the use of Fibonacci retracement lines. Below is a chart of the bellwether S&P 500 Index:
The hourly chart above includes the 20 and 40-period moving averages (respectively colored in brown and teal). Next, we drew Fibonacci retracement lines from the peak of February 22 down to yesterday's low. When using Fibonacci to predict support and resistance levels, we usually focus on just the 38.2%, 50%, and 61.8% retracement levels. But if a stock or index is in an overly strong bullish or bearish trend, we also use the 23.6% level because strong trends may never even retrace to the 38.2% level. Currently, the S&P 500 is showing its 23.6% retracement level at 1,394, just above the 20-period moving average. Just a modest bounce in the stock market should at least enable the S&P to retrace to that area of resistance. If the index rallies to that level and consolidates for a few hours, it will probably make a run at its next line of resistance, the 38.2% retracement level of 1,407. Because the 40-period moving average on the hourly chart often enables trend resumptions, it may initially be difficult for the S&P to rally above convergence of the 38.2% Fibo retracement and the 40-period moving average. Next, take a look at the Nasdaq Composite:
Curiously, the 20 and 40-period moving averages on the hourly Nasdaq chart line up in the same places as they did with the S&P chart. The 20-MA is just above the 23.6% Fibonacci retracement level, while the 40-MA perfectly converges with the 38.2% retracement at 2,413. Pretty interesting, isn't it? Both moving averages and Fibonacci retracements are useful tools for predicting how far a stock or index will correct, but those support or resistance levels become even more powerful when they converge with each other like the 40-MAs and 38.2% retracements have done.
Although the anticipated bounce may not come today, being prepared with a list of key resistance levels gives you a predetermined plan of where to sell any remaining long positions and/or initiate new short positions on stocks and ETFs that have broken below support of intermediate and long-term uptrend lines. When the upside correction finally occurs, it should not be difficult for the S&P and Nasdaq to at least rally to their 23.6% retracement levels. When/if they do so, carefully observe the broad market's price action before aggressively entering new short positions. If the indexes hold and trade sideways near their 23.6% retracement levels for an hour or more, it is bullish and could lead to another leg up to the 38.2% retracements. If, however, the indices immediately reverse back down on the test of their 23.6% retracements, we could be looking at an extremely weak market that lacks the strength for even a small upside price correction. In this situation, a sideways consolidation at the lows for several days ("correction by time") could take the place of a bounce ("correction by price").
With all this talk of a bounce, let us remind you that "oversold" markets can continue to become even more "oversold" before eventually correcting. The same is true of strong markets that appear to be "overbought" in strong uptrends. Therefore, it's dangerous to assume stocks will bounce from current levels just because the S&P has lost five percent in five days. Who's to say the index cannot drop another one or two percent before bouncing? Nevertheless, caution is advised with new short positions, and you may want to tighten your stops to lock in gains on any shorts you've been riding lower since the selloff began. We remain long the UltraShort S&P 500 ProShares (SDS), which is showing an unrealized gain of 2.5 points since our March 1 entry. If necessary, we plan to hold it through a pullback on the way to our price target. Per yesterday's commentary, we also sold short the Utilities HOLDR (UTH), but with reduced share size.
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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:Last week's broad-based correction erased about two months of gains and, not surprisingly, triggered several S2 reversal Stops. Moreover, the market failed to quickly snap back this time, as each of the major indices closed near their worst levels of their intraweek ranges. As such, extreme caution and a tight adherence to protective stops should be observed with all existing long positions. After last week's destruction, the only market segment ETF still on the "ascending trend" list is the S&P Midcap 400 (MDY). As an overall flight to safety, it was very evident that money rotated out of the stock market and into the fixed-income instruments. All the bond ETFs are now in the "ascending trend" list.
Nearly all the industry sector ETFs triggered either their MTG Stops (S1) or Reversal Stops (S2). Please review this week's updated ETF Trend Tracker report for more information. New entries from ascending to descending trend can be quickly spotted by looking for cells that are shaded in light blue color. Many sector ETFs finished proportionately lower in their intermediate to long-term ranges than the major market segments. Biotech (BBH), for example, showed relative weakness by losing a greater percentage than the broad market and closing at levels posted in September, 2006. To easily determine relative strength and weakness, observe the closing price of individual ETFs compared to levels where they were trading previously. The ones that did not give back much relative to the major market segments have higher relative strength. MDY lost only one month of its recent gain, but BBH lost five months of gains. The relatively strong MDY would be a candidate to buy when the market eventually reverses, while BBH should continue to lead the downside and could be sold short on a bounce into resistance.
Across the board, international ETFs showed weakness in sync with the U.S. markets. The majority of international ETFs reversed their uptrends and are now on the "descending trend" list. Extreme volatility, led by China (FXI), triggered our reversal stops and locked in solid gains along the way. Now, we are positioned to profit on the downside if the market maintains its newfound weakness.
Until recently, taking bearish positions in an IRA or other non-marginable account was not possible because short selling cannot be done in a cash account. However, now is the perfect time to remind you about the new ProShares family of ETFs that are inversely correlated to the direction of the broad market. Rather than selling short the S&P 500 SPDR (SPY), for example, buying the ProShares Short S&P 500 (SH) gives you exactly the same position. If the S&P 500 drops 1%, SH will move approximately 1% higher (and vice versa). Even better for small trading accounts are the inversely correlated AND leveraged ProShares ETFs, known as "Ultra" ETFs. Like SH, the UltraShort S&P 500 (SDS) also moves in the opposite direction of the S&P 500, but at a leveraged ratio of 2 to 1. If the S&P 500 drops 1% today, SDS will gain approximately 2%. Be aware, though, that trading the UltraShort ETFs requires discipline because the leverage can just as easily work against you.
Until a few months ago, the ProShares family of inversely correlated and leveraged ETFs was limited to a few major indices such as the S&P 500, Dow Jones Industrials, Nasdaq 100, and the S&P Midcap 400, but the company recently expanded their offerings. In addition to market segments, they now offer UltraShort ETFs that track the major industry sectors, along with ETFs that are tied to various market styles like Value or Growth. If the market happens to enter a lengthy correction, the Short and UltraShort ETFs could become a real lifesaver to your non-marginable retirement accounts. As we see it, there is no longer a good reason to trade expensive, low-volatility ETFs such as SPY or DIA when you can tie up less buying power on a similar ETF that is margined at 2 to 1. This is why we bought the UltraShort Dow 30 ProShares (DXD) in The Wagner Daily last Tuesday instead of selling short the DIAMONDS (DIA). The DIA trade would have realized a similar point gain as the 3.6 points we made in DXD, but the DIA trade would have tied up more than twice as much buying power AND would not have been possible in a retirement or other non-marginable account. In case you're still foggy on how the UltraShort ProShares ETFs work, consider the following example. . .
Assume your account has a total buying power of $100,000. If you wanted to sell short SPY, based on last Friday's closing price, you would be able to sell short 700 shares. If the S&P 500 then falls 2%, SPY will drop approximately 2.8 points (2% of $138.67). This leaves you with a gross profit of about $1,967 (700 shares * 2.8 points).
Now, let's assume the same buying power of $100,000, but you decide to buy the inversely correlated and leveraged ProShares ETF instead. Based on Friday's closing price, you could purchase 1,600 shares of SDS. If the S&P 500 falls that same 2%, the price of SDS will gain approximately 2.5 points (4% of $61.68). It will move 4% instead of 2% because it is constructed in a manner that causes it to move at twice the percentage of the underlying index, and in the opposite direction. With $100,000 in capital exposure, buying SDS instead of selling short SPY would result in a gross profit of $4,000 (1,600 shares * 2.5 points). The bottom line is that the UltraShort ProShares ETFs can provide twice the profit potential, but with the same amount of capital exposure. Obviously, keep this in mind when setting your protective stop too.
Because the ProShares ETFs have less average daily volume than the more popular broad-based ETFs, perhaps you are wondering if liquidity is an issue. Unlike individual stocks, in which liquidity can greatly affect how a stock trades, all exchange traded funds are synthetic instruments. As such, the amount of average daily volume that an ETF trades is, for the most part, irrelevant. Even if a particular ETF had no buyers or sellers for several hours, the bid and ask prices would continue to move in correlation with the market value of the ETF that is derived from the prices of the underlying stocks. An ETF with a low average daily volume may sometimes have slightly wider spreads between the bid and ask prices, but you can simply use limit orders if this is the case. We trade for points, not pennies, so paying a few cents more on occasion is not a big deal.
Next week, we will be adding and tracking several of the new ProShares ETFs on the ETF Trend Tracker. In the meantime, we suggest you take a look at the following URL, which lists all of the ProShares ETFs currently in the lineup: http://www.proshares.com/funds. We do not have any working relationship with ProShares, or any other ETF families, but are simply providing this information for our valued subscribers.
When it was launched, one of the original goals of the ETF Trend Tracker was to minimize risk in the face of extreme market events like we experienced last week. If you used the predetermined MTG Stops (S1) and Reversal Stops (S2), chances are that you locked in substantial profits on long positions and/or realized only small losses on late stage trade entries. Volatility could remain high in the coming week, so be sure to keep those stops in place! Study the new entries to the "descending trend" list to determine which ETFs offer the best risk/reward for potential short entry as well.
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.