November 2, 2010
As we have seen several times over the past week, confusion and indecision were the dominant themes of yesterday's trading session. Overall intraday market action was a tug-of-war between the bulls and bears, as stocks jumped higher on the open, reversed and fell into negative territory by early afternoon, then climbed off their lows in the final 30 minutes of trading. When the dust had settled, it was basically a draw. Both the S&P 500 Index and Dow Jones Industrial Average eked out gains of 0.1%, while the Nasdaq Composite edged lower by 0.1%. The S&P MidCap 400 Index was unchanged, but the small-cap Russell 2000 lost 0.7%. All the main stock market indexes closed near the bottom third of their intraday trading ranges.
Total volume in the NYSE eased 7%. In the Nasdaq, turnover similarly dipped 9% below the previous day's level. In both exchanges, volume was below 50-day average levels. Market internals were also indicative of a session that was noncommittal. In the NYSE and Nasdaq, advancing volume nearly matched declining volume. Understandably, mutual funds, hedge funds, and other institutions have been demonstrating minimal activity ahead of today's midterm elections, which coincides with the start of a two-day Fed meeting on economic policy.
Over the past two weeks, we have pointed out and analyzed a substantial number of solid technical ETF trade setups for traders to consider. However, due to a general lack of price momentum in recent days, we have passed on "officially" entering many of these setups in our model ETF portfolio. Because most of these setups we discussed have simply been spinning their wheels since triggering their valid entry prices, the subjective decision to lay low was apparently the right decision. A quick look at recent price action of the S&P 500 SPDR (NYSEARCA:SPY), a broad-based ETF proxy for the overall equities markets, clearly shows the apathetic environment the stock market is stuck in. Below is an hourly chart of SPY that shows the market's confusion over the past two weeks:
As shown on the chart above, SPY has been little changed over the past two weeks (up approximately 0.4%). However, there has been a lot of intraday and day-to-day volatility throughout that period. The pink rectangles inserted on the chart above are used to highlight the numerous instances of large opening "gaps" in the broad market, both up and down, that have led nowhere or reversed intraday. Notice that a majority of days over the past two weeks demonstrated this indecisive and erratic behavior. Yesterday was only the latest example of such action, as SPY began the day sharply higher, then reversed and began selling off an hour later.
Considering what's been happening to SPY, it's not surprising that most ETFs, even in strong sectors such as emerging markets, have lacked momentum over the past two weeks. The danger in such a market environment, particularly for novice investors and traders, is the temptation to overtrade. This happens because many newer traders feel they need to be in the markets every day, lest they "miss out" on potential opportunities. But the reality is it's very easy to lose money by "churning" one's account through overtrading when there's really not much happening in the markets.
There are times when cash (either US dollars or foreign currency ETF) is one of the best positions to hold. Perhaps we are entering one such period. But for individuals who are unwilling or unable to substantially reduce their trading activity, for whatever reason, there are two things that can be done to reduce overall risk in the current market environment. The first is to reduce position size. If, for example, your normal maximum risk per trade is $500, consider temporarily reducing that number by 25 to 50%.
Another strategy to reduce risk is to require new trade entries to be profitable by the end of the day, or not take them overnight. We utilized the strategy yesterday, when we bought iShares US Telecom Sector (NYSEARCA:IYZ) on yesterday morning's opening gap above resistance, but subsequently made a judgment call to scratch the position (via Intraday Trade Alert) when broad market selling pressure caused IYZ to fall back to a few cents below our entry point. If the market would've followed through on yesterday morning's strength, the position probably would have been showing an unrealized gain by the close. But since that didn't happen, we eliminated all risk by simply closing the trade near our entry point instead. No harm done.
With a bit of luck, trend conditions may improve after the conclusion of two big events this week: US midterm elections (today) and a 2-day Fed meeting on economic policy (today and tomorrow). A favorable reaction to these events could attract big money from the sidelines, which could spark a tradeable resumption of the current, intermediate-term uptrend. Conversely, a negative reaction could lead to a substantial price correction in the broad market. For the longer-term health of the stock market, a substantial pullback would not actually be a bad thing, as it would subsequently create new bullish setups with a better chance for profitability than many of the patterns we are seeing right now. Regardless of what occurs, remember one thing: the actual outcome of today's elections or the specific verbiage of tomorrow's Fed announcement does not matter. Rather, the only thing that matters is the market's reaction to those two events. As always, remember to trade what you see, not what you think!
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: firstname.lastname@example.org.
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