Table of Contents


• Broad Market Analysis - Market capitulation. . .or not?
• A lesson in setting protective stops
• MTG Stalk of the Week - UTX short (an actual trade)
• ETF Trend Tracker weekly commentary

NOTE: The following commentary appeared in the June 27, 2008 issue of The Wagner Daily, which was sent to subscribers before the market opened today. As anticipated, the gold ETFs discussed below cruised even higher in today's session.

The Fed spoke on Wednesday and the market listened, but the message certainly did not digest well the following day. After gapping sharply lower on the open, the main stock market indexes trended steadily south throughout Thursday's entire session before finishing at their dead lows of the day. Important levels of technical support were broken, as the major indices averaged losses of approximately 3%. The benchmark S&P 500 plunged 2.9%, the Dow Jones Industrial Average 3.0%, and the Nasdaq Composite 3.3%. The small-cap Russell 2000 and S&P Midcap 400 indices held up only slightly better, tumbling 2.5% and 2.7% respectively. The large-cap Nasdaq 100 suffered a painful 4.1% loss.

Turnover spiked higher across the board, indicating mutual funds, hedge funds, and other institutions were behind the selling. Total volume in both the NYSE and Nasdaq rose 7% above the previous day's levels. Trading remained above 50-day average levels for the third consecutive day. Not surprisingly, market internals were as ugly as they get. Declining volume in the NYSE trounced advancing volume by a whopping margin of 11 to 1. The Nasdaq adv/dec volume ratio was negative by more than 8 to 1.

The overly bearish breadth tells us very few stocks escaped yesterday's selling pressure, but the gold and silver sector managed to buck the bearishness, and did so in a big way. The gold and silver sector has been very whippy and erratic in recent weeks, as evidenced by the negative outcome of several buy entries into iShares Silver Trust (SLV). However, yesterday's action in the sector was substantially more bullish than it was during recent failed breakout attempts. First, StreetTRACKS Gold Trust (GLD), which is tied to the price of the spot gold commodity, closed at its intraday high. Over the past several months, GLD has had a tendency to gap higher on the open, but immediately sell off intraday. This was not the case yesterday. Further, volume in GLD rose to nearly twice its average daily level, pointing to institutional demand on its breakout above horizontal price resistance, which is shown below:

The Market Vectors Gold Miners (GDX), comprised of a basket of individual gold mining stocks, also had a great day. GDX zoomed nearly 6% higher, volume surged higher, and the ETF broke out above it 50-day MA and three-month downtrend line. This is shown on the daily chart of GDX below:

Frankly, the wild, unpredictable opening gaps of the precious metals make us a bit reluctant to hold GLD or GDX overnight. However, all choppy ETFs eventually resolve themselves into steady trends in one direction or the other. If GLD and GDX continue to act well for the next several days, they signal they are ready to enter into new intermediate-term uptrends. In the meantime, until we receive that confirmation, daytraders should consider buying these ETFs on intraday pullbacks, then selling into upward momentum later in the day. This plan of action was suggested to subscribers yesterday morning, so kudos to those who took advantage of our morning suggestion.

On June 24, the Dow Jones Industrial Average bounced perfectly off support of its prior low from March, lending hope to the possibility of at least a near-term bottom. Yesterday's sell-off, however, dashed that scenario to pieces. After free-falling more than 350 points, the blue chip index sliced through support of its March 2008 low, and closed at its lowest level since September of 2006. The Dow's convincing breakdown to a fresh 52-week low is shown on the daily chart below:

The dashed horizontal line on the chart above marks the prior 52-week closing low that was set on March 10. On any rally attempt, we can now expect that prior level of support to act as new resistance. When the Dow bounces to approach that new resistance level around 11,740, traders and investors who failed to sell during yesterday's breakdown will rush to the exit doors in an attempt to "just break even." This is the psychology behind the creation of price resistance levels.

The broad-based S&P 500 Index is approaching key support of its 52-week low, but is still holding just above it. A drop of just another 10 points (0.8%) will cause the S&P to violate its 52-week closing low of 1,273, which was set on March 10. Again, the dashed horizontal line marks that level:

Despite yesterday's 3.3% pummeling, the Nasdaq Composite is still well above its March low. The index is even above its 61.8% Fibonacci retracement from its March low to June high. Because of the relative strength the Nasdaq continues to exhibit, one should expect the Nasdaq to be the first of the major indices to surge higher when the broad market eventually manages a substantial bounce.

Yesterday's blowout may raise the question of whether or not the stock market has reached a level of "capitulation," which occurs when stocks form a significant bottom after a massive series of drops. Although the long, red bars on daily charts of the major indices may hint at capitulation, the volume levels failed to confirm. When stocks capitulate, the sell-off is typically accompanied by the largest volume levels of the entire downward move. On the daily chart of total NYSE volume below, notice that yesterday's activity was substantially below its June 20 volume level:

One could logically argue that volume levels were artificially inflated by "quadruple witching" options expiration on June 20, but yesterday's turnover just didn't seem to indicate the last of the bulls had finally thrown in the towel. Historically, major market bottoms have not formed until that occurs. Further, we expect the S&P 500 and Nasdaq Composite to follow the Dow in testing their 52-week lows before traders regain enough conviction to step back in to the buy side of the market.

If you're already short the stock market, you're undoubtedly sitting pretty, and have no reason to be concerned as long as protective stops are trailed tightly to lock in gains. But while it doesn't seem the stock market has reached an absolute level of capitulation, new short entries at current levels do not provide very attractive risk/reward ratios. If you're not presently on the short side, use your time to develop a list of ETFs that have held relatively well throughout the market's recent selling, then wait patiently on the sidelines. When the market eventually flashes convincing signs that a bottom has formed, you'll be ready like a sniper to immediately enter the strongest ETFs in the market. Those ETFs, of course, should be among the first to rally back towards their prior highs. We stopped out of Claymore Global Solar Energy (TAN) because the "bull flag" pattern failed yesterday, but this is one ETF we'll be watching for a potential re-entry point when stocks reclaim its footing. Unless strictly daytrading, there is no good reason to be on the long side of the market right now. Don't be a hero by haphazardly trying to pick a bottom. Instead, wait for the market to show its hand and trade what you see, not what you think!

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.

The following is a simple comparison of a few stop placement techniques, and an explanation of why we use tight "Darvas stops" when trading breakouts. The stop is named after Nicolas Darvas, who used this technique in one of the all-time classic trading books he authored, How I Made 2,000,000 in the Stock Market. Please keep in mind there is no "correct" method for stop placement, and that any method used will have its pros and cons. Traders should select a technique they are comfortable with, and one they can execute with confidence.

Below is a weekly chart of MICC. This setup is just an example, and not a recommendation to buy, as overall market conditions are weak.

Note the bullish double bottom pattern and the tight handle that has formed just above the mid-point. This is a typical breakout setup with a nice five-week handle that is about 10% in width. Let's drop down to the daily chart for a more detailed look:

As we can see, MICC is a clear buy over the highs of the range (above $121.00). That's the easy part, but where do we place our stop? Here are a few suggestions:

• Place a stop beneath the lows of a range - This is the most popular method for traders, and unfortunately the most obvious. The pros are that a stop beneath the lows of the range allows the price action to take us out of the market, rather than our opinions. There is no guessing action here, as a close beneath this level would suggest further weakness. The problem with this stop is it's so obvious, which makes it an easy target for a stop run. Why? When a breakout fails, it will often reverse hard, fall back to the lows of range, and usually undercut the lows to take out the obvious stops. All traders at one time or another have felt the sting of watching a breakout fail and trigger your stop, only to watch the stock immediately reverse and rip to new highs. In MICC, our stop would be just below $109.92, which is a 9% stop from our $121.00 buy entry.
  
  
• Place stop 5-7% from trigger price - This technique is simple, yet effective, because the majority of quality breakouts do not retrace more than a few percentage points below the entry before ripping higher. The drawback to this stop is it does not take prior swing lows (support) into consideration, as the stop is placed a blind 5-7% from the entry. In MICC, our 5% stop would be at $114.95, which is not beneath the lows of the range.
  
  
• Place a "Darvas style" stop just below the entry - This technique calls for a stop to be placed 1-3 points below an entry, depending on the stocks volatility. For example, a $30.00 breakout entry may have a $29.00 stop, or a $80.00 entry would have a $78.00 buy stop. A stock with high volatility and a $300.00 entry price may need a 3-4 point stop. Darvas stops demand strong price action from breakouts. A good breakout shouldn't need more than a few points of wiggle room to prove itself. If it does, it probably isn't ready to go and will need more time to consolidate. The benefit to this type of stop is that if a breakout fails, you will exit pretty early, saving your money and sanity. You would then be in a good position to re-enter if/when the setup triggers again. The drawback to this stop is you can get whipped out of the stock more frequently. In MICC, a Darvas stop could be placed 2.5 points below the entry, at $118.49.
  
  
• So which technique is best? - That depends on the individual trader. When placing a stop beneath the lows of a range, if your stopped out, its very tough to re-enter due to the psychological aspect. Fear of taking another big loss if it fails again is tough to overcome. A 5-7% stop is very solid, but the higher priced stocks will often carry way too big of a stop. If we are buying a breakout at $250, a 5% stop is 12.5 points away (this results in extremely small share size as well). We would never need more than 3-4 points of wiggle room to figure out if a breakout isn't working. The Darvas stop allows us to exit quickly if the trade doesn't work, which keeps us fresh to re-enter if the trade reverses back up through our trigger point. In each scenario, note that we would use the same share size. Though most traders would increase their share size using a tight Darvas stop, this defeats the purpose, as it would result in heavier losses due to the quicker stop outs.
  
  For example, if we bought MICC at $121.00, with a 5% stop at $114.95, and we want a maximum risk of $1,000, our size is 165 shares ($1,000/5.05 point stop). Now, if we're using a Darvas stop, we enter at the same price of $121.00, but with a stop of $118.49 and the same 165 shares. If we stop out of our position using the full 5% stop, we are out $1,000. If the stock reverses, we would have to make a tough decision to get back in, risking another $1,000. But with the Darvas stop, we are risking just 2.5 points, with 165 shares, or just $412. If we were to stop out at $118.49 and the action immediately reversed, we could easily; get back in, as we are only down $400 using a Darvas stop, versus $1,000 using a 5% stop. To apply this sort of stop, one must always be watching the market, and not be afraid of re-entering. If you use the Darvas stop and have problems re-entering, you will end up missing too many breakouts. Traders who can't watch the market all day would do much better using a 5% loss.

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, we are presenting you with an educational explanation of an actual trade we entered and closed for a large profit. It was a short sale in United Technologies (UTX). Below is a daily chart:

• The chart of UTX above lends some perspective on the short setup before we get into specifics.
• UTX initially came onto our radar screen after spotting the heavy volume breakdown back on June 6. As such, we put the stock in our personal watchlist for further review.

Next, let's take a more detailed look at the setup:

Anytime there is an obvious breakdown in a chart pattern, the short sellers pile in with hopes of catching some downside momentum. However, obvious short setups such as the break of an uptrend line, or the break of a prior low, are difficult to pull off because these moves often lead to sharp reversals we refer to as "stop runs," which punish all the "late to the party" bears. Because of this, we often wait for a significant bounce to occur after the first breakdown before initiating a short position. This occurred on June 12, trapping all the short sellers and igniting a "stop run" that puts the short sellers to the test. Let's see how UTX subsequently played out:

As UTX pushed higher, we expected the price action to run into the 20-day moving average, and possibly push slightly above it, before reversing. UTX stopped just shy of the 20-day MA, as the gap up on June 17 did not hold. Once the gap failed, we gave UTX a bit of time to settle down, and we sold short at $68.39. UTX did not drop right away, but it remained below its 20-day MA for five sessions before giving way to the heavy selling in the broad market. We exited our short position on June 26, into major weakness, as the stock printed two consecutive wide-ranged bars. High volatility like this is usually a good time to exit a swing long or short position. We locked in a quick five-point gain, but also did so from a low-risk entry point, in a setup going in the same direction as the broad market. Subscribers to The MTG Stalk Sheet also experienced several more highly profitable short sale trades in recent days.

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.

Click to view all actual past issues of The MTG Stalk Sheet in the "Archives" section of the MTG web site.

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.

Last week was quite whippy, as the Nasdaq Composite surged 1.3% higher last Thursday, but plunged 2.3% on Friday. Increasing volume both days caused the Nasdaq to register a bullish "accumulation day" that was followed by a bearish "distribution day." All the major indices declined for the week, but some more sharply than others. The small caps (IWM), mid caps (MDY), and the Nasdaq 100 (QQQQ) are all showing relative strength by holding above their prior lows from mid-June. Other major indices, however, are nearing their 52-week lows set in March. The Dow Diamonds (DIA) is leading the way lower, while the Dow Dividend (DVY) has already declined enough to test its January low anomaly. Look for more indices to trigger into the "descending trend" list if weakness continues into next week.

In this weak market environment, it's best to pick out leading sectors to the downside (those with relative weakness) in order to understand which industries are influencing market conditions the most. Regional Banks (IAT), for example, was down sharply for the week, but it formed a bullish bottoming pattern into Friday's close. Pharmaceuticals (PPH) continue to exhibit weakness, dipping just below the March support level. Consumer Staples (XLP) and Consumer Discretionary (XLY) performed the worst last week, and broke several support levels as they accelerated lower. Commodities (DBC), on the other hand, consolidated near its recent highs. US Oil (USO) also consolidated, as Natural Gas (UNG) surged a little higher.

The fixed-income (bond) ETFs rallied off their lows and showed low volatility. All fixed income ETFs are in the descending trend and trade below their trigger levels.

The International markets reacted negatively during Friday's trading session. Several ETFs gapped down at the open, and subsequently moved lower throughout for the day. Europe (FEZ) was sharply lower and triggered stops in the process. FEZ is new to the "descending trend" list. Most chart patterns do not offer any near-term support levels, so there may be some expanding volatility as we enter the summer.

Behind the scenes, we are currently in the process of giving the ETF Trend Tracker a major facelift. The dramatically new and improved report will simplify the process of determining which ETFs offer the best long-term entry opportunities each week. The new Trend Tracker will also be more interactive and action oriented. Expect to see a beta of the new report by the end of July. In the meantime, we would like to receive the input of our valued subscribers. If there is a specific suggestion for how you would like to see the report improved, simplified, or expanded, please send us an e-mail.

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.

Click to view all actual past issues of the ETF Trend Tracker in the "Archives" section of the MTG web site.