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Keeping the market correction in perspective- July 6, 2010

|Includes: PowerShares DB Agriculture ETF (DBA), DIA

An indecisive, range-bound day of trading preceded the holiday weekend last Friday, as stocks drifted lower in the morning, then recovered back to unchanged levels in the afternoon. However, selling pressure in the final ten minutes of trading caused the major indices to again finish the day in negative territory. The S&P 500, Nasdaq Composite, and Dow Jones Industrial Average registered identical losses of 0.5%. The small-cap Russell 2000 and S&P Midcap 400 indices declined 1.0% and 0.7% respectively. Because of the last-minute weakness, the main stock market indexes finished just below the middle of their intraday ranges.

Not surprisingly, turnover in both exchanges eased substantially. Total volume in the NYSE was 32% lighter than the previous day's level. Similarly, trading in the Nasdaq dipped 38%. Volume typically recedes ahead of three-day weekends, as investors and traders leave their desks early. Last Friday's session was no exception. In the NYSE, declining volume exceeded advancing volume by less than 3 to 1. The Nasdaq adv/dec volume ratio was negative by just over 2 to 1.

In our June 28 commentary, we pointed out a potential buy setup in PowerShares Agriculture Fund (NYSEARCA:DBA), an ETF comprised of a basket of agricultural commodities futures contracts. Specifically, we said DBA "appears to be reversing its long-term downtrend, and is now showing signs of relative strength. While the S&P 500 lost 3.5% last week, DBA gained 0.5%. More importantly, DBA has broken out above resistance of a 6-month downtrend line, and is now consolidating in a tight range, just above new support of its 50-day MA. A move above its June 21 high of $24.43 (the high of the recent range) would trigger a potential entry point for traders looking to take advantage of the intermediate-term trend reversal." But rather than rallying above its June 21 high, DBA sold off sharply the following day, falling below the low of its range and 50-day moving average. When that happened, we lowered our buy trigger price to just above the high of that day (June 29), and DBA zoomed back up on June 30, triggering our buy entry. This is illustrated on the daily chart of DBA below:

DBA

Our entry into DBA was a classic example of buying an "undercut," a setup that occurs when a stock or ETF briefly drops below an obvious level of support, shaking out the "weak hands," then snaps right back a day or two later. When this happens, traders and investors who quickly sold at the first hint of trouble are forced to jump back in, or else miss the move. Since the overhead supply has been absorbed by the previous selling action, this leads to further upside momentum. As such, we bought DBA at a price of $24.07, when it rallied back above its June 29 high and 50-day MA. Since then, it has been consolidating in a tight, sideways range, near its June 30 high. In the coming days, we anticipate a breakout above resistance of its three-month downtrend line, which would help confirm a reversal of the intermediate-term trend. Traders who missed our initial buy entry might consider a secondary entry point on a reversal above that downtrend line (the dotted blue line on the chart above).

After suffering losses every day last week, the major indices begin this holiday-shortened week at fresh lows of the year. Unfortunately for the bulls, the mid-June bounce off the May lows proved to be rather short-lived, and prior horizontal price support of the February, May, and June lows will now act as resistance. Furthermore, as we've been anticipating, several of the indices are now following through with the formation of bearish "head and shoulders" patterns on their weekly charts.

As stocks have closed lower in nine of the past ten sessions, it's quite reasonable to expect at least a very short-term bounce going into this week. However, in the intermediate-term, the major indices are actually poised for resumption of their downtrends that began in April. Still, it's important to keep the current market correction in perspective. On a longer-term basis, for example, stocks have still only retraced about one-third of their gains from the March 2009 lows to April 2010 highs. Below, this is annotated on the weekly chart of the Dow DIAMONDS (NYSEARCA:DIA), a popular ETF proxy for the Dow Jones Industrial Average:

DIA

Because stocks typically fall faster than they rise, one might have the gut feeling the stock market's substantial losses from the April highs have been so damaging that the recovery off the March 2009 lows has reversed back down. But as the chart above illustrates, this is not the case. In trending markets, a Fibonacci retracement to the first major support level of 38.2% is quite common, and indicates no immediate danger of a dominant trend reversal. A decline below the 50% retracement would significantly increase the odds of a long-term trend reversal, and a pullback to the 61.8% retracement level would seriously endanger the uptrend that's been in place for more than a year. But for now, we simply view the multi-month correction as a healthy digestion of the massive gains realized since March of 2009. It's also an important, overdue reminder to traders and investors that markets still move both up and down.


Open ETF positions:

Long - TLT, UNG, UUP, DBA
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.



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Disclosure: Long TLT, Long UNG, Long, UUP, Long DBA