Table of Contents


• Broad Market Analysis - Market correction finally spreads to agriculture
• A lesson in setting protective stops
• MTG Stalk of the Week - LM short (an actual trade)
• ETF Trend Tracker weekly commentary

NOTE: The following commentary appeared in the July 1, 2008 issue of The Wagner Daily, which was sent to subscribers before the market opened today. As anticipated, the agriculture ETF discussed below moved even lower in today's session, while the gold ETFs discussed below continued higher.

Stocks closed out the second quarter of the year with little fanfare yesterday, as the major indices finished with mixed results. The broad market feebly attempted to rally in the morning, then drifted back down in the afternoon. Weakness in the tech arena caused the Nasdaq Composite to fall 1.0% and suffer its third straight day of losses. The S&P 500 eked out a gain of 0.1%. The Dow Jones Industrial Average was unchanged. Small and mid-cap stocks showed relative weakness alongside of the Nasdaq. The Russell 2000 and S&P Midcap 400 indices shed 1.2% and 0.5% respectively. The Nasdaq Composite closed at its dead low of the day, while both the S&P 500 and Dow Jones Industrial Average settled near the bottom third of their intraday ranges. Sustaining its worst monthly losses in nearly six years, the S&P 500 plummeted 8.6% in June. The Nasdaq Composite similarly shed 9.1%. Blue chips fared the worst, as the Dow Jones Industrial Average tumbled 10.4%.

Turnover eased across the board, indicating a bit of apathy amongst traders. Total volume in the NYSE was 4% lighter than the previous day's level. Trading in the Nasdaq declined 10%. Despite the slightly higher closing price of the S&P 500, declining volume in the NYSE marginally exceeded advancing volume. The Nasdaq adv/dec volume ratio was negative by approximately 3 to 1.

In yesterday's Wagner Daily, we proposed the idea of buying the StreetTRACKS Gold Trust (GLD) and/or Market Vectors Gold Miners (GDX) on pullbacks to their 20-period exponential moving averages on the hourly charts. Recently, we also wrote a mini-lesson discussing how reliably ETFs can be bought on their first pullback to that moving average after they breakout. Astute short-term traders who paid attention to yesterday morning's GLD/GDX detailed entry suggestion were subsequently rewarded with the ideal buy point later in the afternoon. Looking at the hourly charts of GLD and GDX below, notice how both ETFs perfectly pulled back to nearly touch support of their 20-EMAs at mid-day, then resumed their recent bullish momentum in the afternoon:

Though we provided the parameters for ideal daytrades in GLD/GDX, we did not "officially" buy either ETF because of their recent patterns of nasty opening gap downs. However, since June 26, there have been decidedly stronger trends in the precious metals ETFs. The afternoon resilience of GLD and GDX tells us their multi-month patterns of failed breakouts and unpredictable opening gap downs are probably finished. Looking ahead, the most ideal scenario would be for the gold (and possibly silver) ETFs to consolidate in a tight, sideways range for the next several weeks. If they do, the first breakout above their ranges would be buyable for an intermediate-term trade, not just a quick, momentum-based pop.

Agriculture and fertilizer stocks have been on fire for the past year, but those of you with long-term positions may consider tightening stops to protect your gains. A few leading stocks within the sector have begun to show near-term relative weakness, giving investors an early heads-up that a significant correction may be coming soon. As a proxy for the sector, check out the daily chart of Market Vectors Agribusiness (MOO), which is comprised of forty individual stocks related to various areas of agribusiness:

Looking at the chart above, notice that MOO formed a "double top" formation in mid-June. It then sold off to close below its 50-day moving average (the teal colored line) last week. MOO attempted to quickly reclaim its 50-day MA by gapping higher on yesterday's open, but notice how it sold off to close below its 50-day MA again. With MOO only 6% below its all-time high, it's still too early to call a definitive top. Nevertheless, agribusiness bulls should certainly be cautious with any open long positions. Downside momentum in this sector could be fast and furious if the correction picks up steam.

Thinking about selling short MOO? If so, agressive traders might consider selling short MOO on a break below yesterday's low, while placing a protective stop above the 20-day EMA (63.08). In this case, it is crucial to at least wait for a break below yesterday's low. More risk averse traders who still like the trade idea could simply wait for a breakdown below the June 27 low, then sell short the first subsequent bounce into resistance. Yet another scenario is to scale into a short position by entering partial share size below yesterday's low, then adding to the position on a break below the June 27 low. This enables one to "dip a toe in the water" without falling in the deep end of the pool. Be warned, however, that MOO is now out of sync with the broad market by showing newfound relative weakness as the main stock market indexes may soon attempt to bounce from an "oversold" state. Perhaps short entries into MOO are best handled on an intraday basis until we see how it reacts when the broad market eventually bounces.

As objectively illustrated in yesterday's Wagner Daily, the S&P 500 is trying to decide whether or not it wants to hold at major support of its 38.2% Fibonacci retracement level, which coincides with the low of March. If it follows the path of its brethren Dow Jones Industrial Average, a breakdown to a new 52-week low could be coming soon. On the other hand, traders have the perfect excuse to start buying stocks at current levels, but we need to see the proof first. Capital preservation is key in this highly volatile environment, so there's absolutely nothing wrong with sitting on the sidelines, preserving cash for the next low-risk opportunity that comes along. As always, remember to 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 Legg Mason (LM). Below is a daily chart detailing the setup:

• LM was added to our short watch list during the first week of June, as it consolidated in a tight range, at the lows.
• We noted the bearish "wedging" action that was resolved by a monster gap down and selloff on May 6.
• The big volume on the sell-off told us the downtrend was ready to resume in earnest.
• On June 9, LM cracked the lows of the range, triggering our short entry at $51.97.
  
  

  Let's see how LM subsequently played out:

  
  

• When trading obvious breakdowns at the lows, one can always expect some sort of stop run to shake out the shorts, which is what happened from June 11 to 16.
• After the run on the shorts dissipated, the selling took over as LM confirmed the breakdown on June 23.
• We covered near the lows of the session on June 27, locking in an 8-point gain.

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.

The remaining two Market Segment ETFs fell into the "descending trend" list on a brutal last two days of the trading week. Once their support levels were breached, selling really took hold. Damage was widespread, but small caps (IWM) and the S&P 500 Growth (IVW) held up slightly better than other indexes. Note that Nasdaq 100 (QQQQ) and mid caps (MDY) have yet to trade anywhere near their March 2008 lows. That's a good sign to remember when the markets eventually rally again, as those Market Segments should lead the broad market higher. Yes, a rally will come someday.

Most Industries were hit hard, but it may just be the beginning. The ETF Trend Tracker alerted us to recent downside trend reversals, but we could expect an extension of the descending trend channels in the intermediate-term. In the near-term, consider waiting for at least a small, countertrend bounce before initiating new short positions. Refuge from recent carnage might be found in Biotech (BBH), Pharmaceuticals (PPH), and Healthcare (XLV), as these ETFs held up relatively well last week. Looking at Industries with low levels of direct correlation with the equities markets is also an excellent option. Among the ascending ETFs are: Euro Currency (FXE), Commodities (DBC), Oil (USO), and Natural Gas (UNG). Gold (GLD) and Silver (SLV) also broke out to end the week. Please review the current issue of the ETF Trend Tracker for additional trend reversals that took place last week (rows shaded in pink color) The "Imminent Trend Reversal" alert list is a good place to look for new trade entries in the coming week.

The bond ETFs rallied nicely, as institutions rotated more allocation of funds into the fixed-income arena. Triggering to the "ascending trend" was the long-term 20 yr. T-Bond (TLT). Buying bonds at these reversal inflection points offers investors the benefits of both monthly dividend payments and appreciation of the underlying security.

All the International ETFs we track are now in the "descending trend" list. This week, we added Market Vectors Russia (RSX) to the Trend Tracker. Extending into double digit gains (for short positions) are Hong Kong (EWH), Taiwan (EWT), India (INP), China (FXI), and Korea (EWY). When all the ETFs we track are making gains to the downside, we like our subscribers to take notice of the 100% "hit rate," which is 15 out of 15 International ETFs (not counting RSX). The ETF Trend Tracker typically yields very high hit rates. As such, you will be on the wrong side of the market less often if you follow the entries at MTG Reversal Triggers. Check out the "percentage (%) change" column in this week's report to see our hit rates of other sectors.

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.