Table of Contents


• Broad Market Analysis - How bad was yesterday's carnage?
• The key to finding profitable short setups
• MTG Stalk of the Week - SIGM long
• ETF Trend Tracker weekly commentary

Broad Market Analysis - How bad was yesterday's carnage?

Key breaks of closely-watched support levels in several of the major indices triggered a massive sell-off across the board yesterday. After gapping lower on the open, a reversal attempt in the Semiconductor Index ($SOX) helped stocks try to recover at mid-day. But the bears took control again in the afternoon, sending the broad market to new intraday lows. Small-caps got pummeled, as the Russell 2000 Index swooned 2.8%. The 2.3% loss in the S&P Midcap 400 Index wasn't far behind. The S&P 500 plummeted 2.0%, the Nasdaq Composite 1.9%, and the Dow Jones Industrial Average 1.6%. All of the major stock indexes closed near their worst levels of the session.

On a technical basis, one of the worst things about yesterday's selling spree was the accompanying surge in turnover. Total volume in the NYSE rushed 30% above the previous day's level, while volume in the Nasdaq similarly jumped 22%. The 2.07 billion shares that traded hands in the NYSE was the highest volume day in the exchange since stocks formed their recent bottom in March. The sharply higher volume that accompanied yesterday's losses caused both the S&P and Nasdaq to register another bearish "distribution day." It was the third such day of institutional selling within the past five sessions. In yesterday morning's commentary, we said that "The broad market has basically gone nowhere over the past four days, but a look "under the hood" at the volume patterns discreetly reveals underlying weakness. Because prices continue to hold up pretty well, negative price to volume relationships in the market are not solely enough justification to be bearish on the stock market. Nevertheless, professional traders who monitor underlying internals and volume patterns may begin hovering their fingers over the sell buttons in case prices begin to confirm the early warning signs." Clearly, prices finally confirmed those early warning signs that volume patterns gave us in the preceding four days, causing lots of "sell" buttons to be pushed.

Market internals, particularly in the S&P, were about as nasty as could be. Declining volume in the NYSE crushed advancing volume by a margin of 14 to 1. The Nasdaq ratio was negative by a little more than 6 to 1. Further, the $TRIN reading in the NYSE was only 1.6. Levels above 2.0 to 2.5 are often considered extreme and unsustainable, but yesterday's reading of 1.6 tells us the selling was steady, not indicative of massive panic selling. The bottom line is that, despite the bloodletting, market internals gave no sign of a short-term bottom yesterday.

The most obvious break of support in the broad market was the S&P 500's collapse below its prior downtrend line, 20-day EMA, and the pivotal 50-day MA. This is illustrated on the daily chart below:

Although the S&P 500 dipped below its 50-day MA and recovered back above it several times last month, there is one big difference this time. Prior tests of the 50-day MA were not immediately preceded by a breakout to new highs. This time, the index has broken below its 50-day MA after breaking out to a fresh all-time high just several days ago. When a stock or index fails a breakout to a new high, the bulls who bought the breakout become trapped and are forced to quickly dump their shares. This typically leads to swift selling pressure, which in turn attracts the short sellers who see the failed breakout. Because yesterday's break of the 50-day MA was preceded by a failed breakout to new highs, we would be quite surprised if the S&P 500 promptly snaps back to its highs this time, as it did during last month's tests of the 50-day MA. As for support, the July 11 low of 1,506 is the first line of defense, while the June 27 low of 1,484 provides much more important support.

Both the Nasdaq and Dow fell below support of their 20-day EMAs yesterday, but are still above their more important 50-day MAs. Curiously, yesterday's lows in both indexes coincides with pivotal price support of their respective prior highs. For the Nasdaq, it's the June 20 high of 2,634, while the Dow's prior high of 13,692 was posted on June 1. Dual support of those prior highs may give the broad market an excuse to bounce today, but any rally attempt is likely to fizzle out as long as the S&P remains below its 50-day MA. If the Nasdaq and Dow begin to fail their breakouts by falling below their June highs, support of the 50-day MAs is just below. For now, both of these indexes continue to look much better than the S&P 500. Conversely, the small-cap Russell 2000 is a major index that is looking much worse than the benchmark S&P 500.

Unlike the S&P 500, which failed its breakout to a new high, the Russell 2000 has shown so much relative weakness that it was unable to follow the S&P, Nasdaq, and Dow to new highs. When an stock or index fails to make new highs when the broad market does, it also becomes the first thing to collapse when the broad market eventually pulls back. The recent performance in the Russell is a good example of this.

After closing marginally below its 50-day MA on both July 20 and 23, the Russell completely fell apart yesterday. Not only did it slide 2.8% and close at a 3-month low, but the index also broke below support of its primary uptrend line that had been in place since July of 2006. This breakdown below the one-year uptrend line is shown on the weekly chart below:

Yesterday, the Regional Bank HOLDR (RKH) dropped several more points, hitting our original downside price target of $148.30. As such, we covered our short position into weakness for a gain of more than 8 points over a five-day period. Of the other four ETF positions, only the iShares Nasdaq Biotech (IBB) hit its protective stop. Since our trade setups always target a reward/risk ratio of at least 2 to 1, the capital gain from the RKH trade was double the loss of the IBB trade. Since two of the three remaining open ETF positions are not directly correlated to the direction of the stock market, they held up well yesterday. The CurrencyShares Canadian Dollar (FXC) is looking good, as it gapped to a new all-time high yesterday. The Market Vectors Gold Miners (GDX) pulled back a bit yesterday, but held support of its primary hourly uptrend line. Since FXC is correlated to the movement of the U.S. dollar and GDX is largely tied to the movement of the spot gold commodity, the actual stock market performance going forward is not a big factor for these positions. The PowerShares Clean Energy Fund (PBW) is indeed comprised of individual stocks, but this sector has been largely ignoring recent market dips because solar energy stocks are flaming hot (please excuse the cheesy pun).

As one might have surmised, yesterday's weakness has changed our overall short-term bias on the market from bullish to bearish. As for the intermediate-term, we have shifted from bullish to a neutral bias, pending the outcome of whether or not the Nasdaq and Dow hold above their June highs. Yesterday's action should lead to several ideal short setups in the coming days, specifically for those ETFs that rally into major prior support levels they just broke below. The iShares Russell 2000 (IWM) is one such ETF we will be stalking for a potential short entry. However, considering the broad market just fell two percent in one day, we are reluctant to list new short entries without waiting to see if the market at least attempts to bounce from here. Most of the large one-day drops in recent months were quickly followed up by substantial bounces.

If you wish to learn about Morpheus Trading Group's ETF trade entries on the same day they occur, sign up for a free trial to The Wagner Daily or other MTG services by clicking here (limit one per household). Also, remember that all previously published issues of both The Wagner Daily and The Wagner Weekly are available in the MTG archives. If you are new to our services or wish to broaden your knowledge of ETF trading or our general trading style, we recommend you browse the archives because it is educational and free! Click here to visit the Wagner Daily archives or here to visit the Wagner Weekly archives.

On July 18, we sold short the Regional Bank HOLDR (RKH), in The Wagner Daily, at a price of $156.87. Four days later, we covered the position for a healthy gain of nearly 8.5 points. Since the market may be entering a corrective phase, we thought traders might appreciate a bit of educational commentary on how we determined the ideal entry price for this short sale.

For a long trade setup, one of the biggest things we look for is convergence of several support levels on multiple time frames. For a short trade setup, we like to see the opposite, which is a convergence of resistance levels on multiple time frames. In the case of RKH, a perfect short entry was provided last week when it rallied into major resistance on both its daily and weekly charts. Since longer chart intervals carry more weight than shorter intervals, the first thing we liked was big resistance on the weekly chart of RKH. Specifically, it had rallied into new resistance of its prior uptrend line that it broke below in late June. Notice how RKH was unable to climb back above its prior uptrend line after it fell below it:

With the break of a four-year uptrend providing the main impetus for the short idea, we drilled down to the shorter-term daily chart. Upon doing so, we were pleased to see that RKH had also rallied perfectly into several resistance levels on that time frame as well. Take a look:

First, notice the intermediate-term downtrend line that is illustrated by the descending red line. On both July 16 and 17, RKH formed bearish "inverted hammer" candlesticks after trying, but failing, to break out above the intermediate-term downtrend line. This alone provided a decent short entry, but it was made even better by the fact that resistance of both the 50 and 200-day MAs converged with the downtrend line as well. Going into July 18, our plan was to sell short RKH on a break of its July 17 low. As you can see, our short entry happened on that day's open. Considering resistance of its prior uptrend line on the weekly chart, combined with overhead resistance of the daily downtrend line, 50-day MA, and 200-day MA, it's not surprising that RKH has fallen apart so quickly.

When RKH gapped down yesterday morning, we were prepared to cover and take the profit if it reversed convincingly. However, it showed relative weakness throughout the entire day. By late afternoon, it had fallen to our original profit target of $148.30. Sticking to the pre-determined plan, we closed the position at that time, locking in a profit of 8.4 points. Though it could move lower in the intermediate-term, RKH is likely to move sideways or bounce in the short-term.

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: