Last Thursday, the stock market's intraday price action was a prime example of the importance of having firm rules for managing large opening gaps. On the open, our Wagner Daily long position in the S&P Homebuilder SPDR (XHB) would have triggered our trailing stop price to close the position, while our pre-market setup to buy the UltraShort S&P 500 SPDR (SDS) would have simultaneously triggered for buy entry. Had we taken such action, we would have found ourselves long SDS at the highest level of the day, with a substantial loss or stop-out by the end of the day. Conversely, we would have sold XHB at its lowest level of the day, only to watch it rip more than 11% intraday! Instead, we passed on the SDS buy entry, and remained long XHB throughout the entire day. Was this the result of some divine prophecy? Not at all! It was simply the result of following a firm plan of action, known as the MTG Opening Gap Rules, which we established through experience many years ago.
Due to large changes in overnight supply or demand, both the major market indices and individual stocks and ETFs will often open much higher or lower than where they closed the previous day, which is known as a "gap." Buying or selling short a stock that hits its trigger price due to an opening gap is often riskier than entering a stock that trades through its trigger price in an orderly fashion, as the risk/reward ratio becomes negatively skewed. Likewise, open positions will sometimes gap open beyond their protective stop prices, but immediately reverse back in the right direction. The following details our personal trading rules for handling these tricky situations:
Stocks or ETFs that gap open beyond their trigger prices for entry: For a long setup, we only buy the stock or ETF if it subsequently sets a new high after the first 20 minutes of trading. For a short setup, we only sell short if the equity subsequently sets a new low after the first 20 minutes of trading. In both cases, the stock or ETF must exceed its 20-minute high (for longs) or 20-minute low (for shorts) by at least 10 cents before we will enter the position. Any opening gap of less than 10 cents above or below the trigger price will not prompt use of the gap rules.
Stocks or ETFs that gap open beyond their protective stop prices: If a long position gaps down to open at or below its stop price, we continue to hold the stock for the first 20 minutes of trading, at which point the new stop price is adjusted to 10 cents below the low of the first 20 minutes. For short positions, we adjust the stop to 10 cents above the high of the first 20 minutes.
Going into yesterday's open, our stop in XHB had been trailed to a price of $20.31. Since XHB opened at $20, more than 10 cents below its stop, we automatically applied the MTG Opening Gap Rules to adjust our new stop to be 10 cents below the low of the first twenty minutes of trading. As you can see on the intraday chart below, XHB immediately reversed, never coming even close to breaking its twenty-minute low. We therefore remained in the position, which zoomed to a closing gain of more than 8%:
Per our detailed analysis on the broad market in last Thursday morning's Wagner Daily, we planned to buy the inversely correlated UltraShort S&P 500 ProShares (SDS), but the gap rules saved us again. Our initial plan was to buy SDS above Wednesday's high, so we had a trigger price for entry of $64.12. Since SDS gapped open at a price of $64.84, the gap rules applied, meaning we would now only buy SDS if it subsequently moved above the high of its first twenty minutes. This never happened, so we simply did not buy it. We're pleased about that:
These are just two real examples of how our gap rules can be applied for both managing existing positions and pre-market setups for new trade entry. Obviously, the rules do not work 100% of the time, but they keep us out of trouble time and time again. A trade will sometimes need to be stopped out at a substantially lower price than if we simply closed it on the open. However, the number of times the rules have kept us in a winning trade (such as XHB) has more than made up for the additional losses we have realized when the 20-minute lows were broken and we stopped out lower. A bit of discretion is sometimes required as well, meaning we will occasionally close a position before its 20-minute low if it's looking just plain horrible and doesn't appear to just be a quick "shakeout."
Trading was akin to dodging land mines last week. As such, we are not really interested in aggressively jumping in on either side of the market until things settle down a bit. Remember that capital preservation, not large profits should be your primary focus in the current environment!
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.
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:
We are presently fully in cash. As such, there is no new trade setup this week. In the coming days, we'll be looking to initiate new short positions on stocks and ETFs that have rallied into major resistance levels. The short-term trend is up, but the intermediate and long-term trends remain down. We're looking to take advantage of low-risk short entries on this bounce.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 the most recent ETF Trend Tracker, e-mailed to subscribers last weekend. 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 markets continued to rally off the short-term lows established January 23, and the major indices finished the week at their highs of the session. However, extremely whippy, indecisive action plagued the stock market several days last week. Among downtrending ETFs, a few MTG Stops (S1) were hit along the way. More stops and reversals may begin to trigger next week, locking in gains on the short side, so be sure to keep your stops updated using the latest ETF Trend Tracker report.
All the Market Segment ETFs rallied well, but are now approaching significant resistance and areas of price congestion from last November and December. Showing relative strength, the small caps (IWM) may be the first Market Segment ETF to land back in the "ascending trend" list. Nevertheless, IWM is characterized as having a choppy chart pattern because it triggered into the "descending trend" list only about one month ago.
The Regional Banks ETF (IAT) continues to perform well and is leading the Industry sectors higher. New to the "ascending trend" is the Dow Transports (IYT). Internets (HHH) gapped up Friday, and we are looking for a reversal into the ascending trend within the next couple of days. Again, several more MTG Stops and Reversal Stops/Long triggers will be hit if this rally continues into next week. The only sectors that felt saw negative rotation were Oil (USO), Natural Gas (UNG), and Gold (GLD). The Euro Currency (FXE) is forming the third top of a "triple top" formation and may provide an ideal short entry if a stop is maintained above the top of the range.
Fixed-income (bond) ETFs remained steady and traded sideways for the week.
Several International sectors are also setting up for their Reversal triggers. Mexico (EWW) is the first one to cross over to the "ascending trend" list. Keep a look out for explosive moves in India (INP) and China (FXI). Hong Kong (EWH) and Singapore (EWS) are ones that looked a little flat in a bullish week.
Despite many ETFs poised to trigger to the "ascending trend" list, we suggest avoiding aggressive entries on the long side of the market. Overall intermediate and long-term trends remain "down," so stocks could resume their primary downtrends at any time. Generally, risk/reward still favors the short side of the market, so one might consider initiating new mid-trend short entries on ETFs that are rallying into major areas of resistance. Remember to use our annotated charts to assist in your decision making.
Alert 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.
The Morpheus Trading Group web site has just been updated to show several live seminars in which Deron Wagner will be participating in the beginning of 2008. The highlight of these events is the Live ETF Trading Seminar in Fort Lauderdale, Florida on February 9. Hurry, there is little time left to register! For those of you who prefer the north, Wagner will be presenting at the New York International Traders Expo. less than two weeks later. For details of these and other upcoming events, please visit the Upcoming Trading Seminars web page.