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Deron Wagner is the founder and portfolio manager of Morpheus Trading Group. His daily focus is managing and trading the Morpheus Capital Hedge Fund, which he founded in April of 2004. He also teaches his swing trading strategy with The Wagner Daily newsletter, which provides exact entry, exit,... More
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Morpheus Trading Group
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Morpheus Trading Group - swing trading blog
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Advanced Technical Analysis of ETFs
  • What are the consequences of yesterday's decline? - May 7 0 comments
    May 7, 2010 9:06 AM

    Averting massive destruction, the major indices bounced back from disastrous intraday losses of approximately 10%, but stocks still finished sharply lower. Both the S&P 500 and Dow Jones Industrial Average swooned 3.2%, while the Nasdaq Composite cratered 3.4%. The small-cap Russell 2000 and S&P Midcap 400 indices shed 3.8% and 3.4% respectively. All the main stock market indexes closed just above the middle of their gargantuan intraday trading ranges, but at the lowest levels of the past two months.

    Yesterday's turnover was tremendous, as volume in both the NYSE and Nasdaq rocketed to its highest levels since 2008. Total volume in the NYSE raced 70% above the previous day's level. Trading in the Nasdaq similarly leapt 55%. Normally, a higher volume loss, known as a "distribution day," is a bearish sign of institutional selling into strength. However, one exception is when volume spikes higher on a "down" day, while stocks have already been selling off. Therefore, in this case, yesterday's monstrous volume that accompanied the huge sell-off could actually be interpreted as a bullish sign of very near-term "capitulation." Nevertheless, this signal alone does not mean one should run out with reckless abandon and immediately start buying stocks. There could easily be another violent shakeout or two before the broad market finds its footing.

    Over the past two weeks, we've been warning subscribers about the negative volume patterns that had begun creeping into the broad market, specifically higher volume losses ("distribution") combined with lighter volume gains. Since we said such patterns of institutional distribution typically precede substantial corrections in the broad market, this week's decline was not shocking. However, it was admittedly a bit surprising that major support of the January 2010 high of the S&P 500, discussed in yesterday's commentary, only produced a modest bounce that lasted less than an hour before the index collapsed intraday. Moreover, it was astonishing that the S&P 500 plunged all the way down to "undercut" its 200-day moving average, more than 6% below the 50-day moving average the S&P 500 tested only the previous day.

    The popular financial media outlets have been abuzz with speculation regarding the cause of yesterday's incredible afternoon collapse that briefly caused the Dow to register its second largest intraday decline in history (more than 9%, surpassed only during the 1987 crash). Reports of the culprit have ranged from the erroneous input of a large institutional sell order in the futures markets to computerized trading that led to a lack of liquidity. But although some thick individual stocks (such as PG and ACN) obviously showed evidence of something gone horribly haywire, we believe yesterday's action was nothing more than a long overdue "shakeout" from the rally off the March 2009 lows, albeit an overly vicious one. Both the NYSE and Nasdaq reported no system malfunctions at any time during yesterday's session, and computerized "program trading" is nothing new and has been going on for years.

    In the April 27 issue of The Wagner Daily, we illustrated how the S&P 500 had rallied to within a few points of its 61.8% Fibonacci retracement level, from its October 2007 high down to its March 2009 low. Specifically, we said, "When markets form a substantial counter-trend bounce, they typically retrace 38.2% to 61.8% of their prior moves before resuming the dominant trend . . . Since the 61.8% Fibo retracement level is considered the "last line of defense" before a trend completely reverses itself, the current pricing area of the S&P 500 is pivotal. If the index manages to convincingly bust through the 61.8% retracement level shown above, odds of the S&P recovering all the way back to its prior highs of 2007 increase substantially. However, IF the market is going to head back down and resume its dominant, long-term downtrend, this is area where it would likely happen."

    Since this month's correction started as the S&P 500 tested its 61.8% Fibonacci retracement, the market action of the next several weeks to months will likely determine whether or not there is a shift in the long-term trend of the markets. Given yesterday's action, the rally off the March 2009 lows now finally has a chance to prove its own legitimacy. If, for example, the S&P 500 manages to fully recover and break out to a new 52-week high, one could probably declare the multi-year bear market is finally dead. However, until that happens, traders and investors should be prepared for several more scary "shakeout" attempts along the way.

    Whatever actually caused yesterday's intraday meltdown is not our concern. What really matters is there are no clear ETF trade setups on either side of the market right now. At the least, we need to let the market settle down for a few days before determining which side of the market yields the best odds of profitability. Some buying opportunities may soon arise, but right now there is too much technical damage on the charts to have any clear indication. Given the results of yesterday's session, we were thrilled to have been positioned 100% in cash going into the day. Because we heeded the warning of the volatile price action and institutional distribution that preceded the plunge, our full cash position enabled us to preserve all the hard-earned profits of the first four months of the year. Patience and discipline in the current environment remains of paramount importance.


    Open ETF positions:

    Long - (none)
    Short (including inversely correlated "short ETFs") - (none)
    The commentary above is an abbreviated version of a daily ETF trading newsletter, The Wagner Daily. Regular subscribers receive daily updates on all open positions, as well as new ETF trade setups with detailed trigger, stop, and target prices. Intraday Trade Alerts are also sent via e-mail and/or text message, on as-needed basis. For your free 1-month trial to the full version of The Wagner Daily, or to learn about our other services, please visit morpheustrading.com.

    Deron Wagner is the Founder and Head Portfolio Manager of Morpheus Trading Group, a capital management and trader education firm launched in 2001. Wagner is the author of the best-selling book, Trading ETFs: Gaining An Edge With Technical Analysis (Bloomberg Press, August 2008), and also appears in the popular DVD video, Sector Trading Strategies (Marketplace Books, June 2002). He is also co-author of both The Long-Term Day Trader (Career Press, April 2000) and The After-Hours Trader (McGraw Hill, August 2000). Past television appearances include CNBC, ABC, and Yahoo! FinanceVision. Wagner is a frequent guest speaker at various trading and financial conferences around the world, and can be reached by sending e-mail to deron@morpheustrading.com.



    DISCLAIMER: There is a risk for substantial losses trading securities and commodities. This material is for information purposes only and should not be construed as an offer or solicitation of an offer to buy or sell any securities. Morpheus Trading, LLC (hereinafter "The Company") is not a licensed broker, broker-dealer, market maker, investment banker, investment advisor, analyst or underwriter. This discussion contains forward-looking statements that involve risks and uncertainties. A stock's actual results could differ materially from descriptions given. The companies discussed in this report have not approved any statements made by The Company. Please consult a broker or financial planner before purchasing or selling any securities discussed in The Wagner Daily (hereinafter "The Newsletter"). The Company has not been compensated by any of the companies listed herein, or by their affiliates, agents, officers or employees for the preparation and distribution of any materials in The Newsletter. The Company and/or its affiliates, officers, directors and employees may or may not buy, sell or have positions in the securities discussed in The Newsletter and may profit in the event the shares of the companies discussed in The Newsletter rise or fall in value. Past performance never guarantees future results.

    Charts created by TradeStation (tradestation.com).

    © 2002-2010 Morpheus Trading, LLC
    Reproduction without permission is strictly prohibited.


    Disclosure: none
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