A positive reaction to the first "official" day of quarterly earnings reports enabled stocks to score another advance yesterday, marking the broad market's sixth consecutive day of gains. The main stock market indexes gapped sharply higher on the open, then drifted sideways to slightly higher throughout the rest of the session. The Nasdaq Composite jumped 2.0%, the S&P 500 1.5%, and the Dow Jones Industrial Average 1.4%. The small-cap Russell 2000 and S&P Midcap 400 indices rose 3.4% and .2.4% respectively. A pullback in the final minutes of trading prevented the major indices from finishing at their best levels of the day, but the broad-based indexes still closed in the upper quarter of their intraday ranges.
Turnover surged higher across the board, causing both the S&P and Nasdaq to convincingly register a bullish "accumulation day." Total volume in the NYSE soared 30% above the previous day's level, while volume in the Nasdaq similarly rose 29%. The higher volume gains pointed to participation amongst mutual funds, hedge funds, and other institutions. However, despite the volume surge, turnover in both exchanges remained below 50-day average levels. Furthermore, although yesterday's volume was the highest of any "up" day since the July 1 lows, trading was still heavier in most of the "down" days in the latter half of June. It's also notable that a majority of yesterday's gains were merely the result of the broad market's sharp opening gap. Thereafter, during the regular trading session, stocks only slightly managed to build on their opening gains. Nevertheless, market internals were convincingly strong. In both the NYSE and Nasdaq, advancing volume trounced declining volume by a margin of 12 to 1.
The overall trading environment over the past month has become one of extremes. Just a few weeks ago, in the latter half of June, market sentiment was so negative that the broad market suffered a losing streak in which stocks declined in 10 out of 11 sessions. The major indices had also broken down to new lows of the year. But starting on July 6, the main stock market indexes began a winning streak that has lasted six consecutive days (and still counting). On the daily chart of the S&P 500 SPDR (NYSEARCA:SPY) below, notice the "inverse wedge" pattern that has been forming for the past several months:
The inverse wedge pattern is indicative of growing indecision in the market, as the pattern shows several instances of both failed breakouts to the upside, as well as failed breakdowns to the downside. Rather than assuming a serious trend may develop in either direction, a better plan of action may be to trade the support and resistance channels. In other words, position one's self on the short side (or simply go to cash) when the S&P runs into the upper channel of the wedge, while entering long positions on each test of the lower channel support. Now that the market's new trading range is becoming apparent, and substantial follow-through in either direction is unlikely, we plan to close our existing ETF positions as they start to show a decent profit, rather than letting the winners ride as we normally would. Then, we will reposition the portfolio to take advantage of the swings, in both directions, between the support and resistance channels shown above.
Right now, several of the major indices are at pivotal levels of resistance. Circled in pink on the chart above, SPY (an ETF proxy for the benchmark S&P 500 Index) closed just below key resistance of its 50-day moving average. The last time SPY ran into its 50-day MA from below was in mid-May, after the infamous "flash crash." Two days later, it stalled and reversed back down in a big way. A repeat of that action would send SPY back down to test its July lows, at which point it would be critical to see whether or not those prior lows remain intact. Even if SPY manages to reclaim its 50-day MA, more significant resistance of the 200-day MA (the orange line) hovers overhead. Obviously, it's possible that SPY continues zooming higher from here, breaking out above its June 21 "swing highs" without even looking back. However, we feel this scenario is much less likely than a sell-off first causing the S&P to test its July lows.
The Dow is also at a pivotal level of resistance, as it has moved above its 50-day MA, but closed right at resistance of its 200-day MA yesterday. This is shown on the daily chart of the Dow Jones Industrial Average below:
Finally, we see the Nasdaq Composite is now approaching resistance of both its 50 and 200-day moving averages, which are converging together:
With key resistance levels overhead, as well as a plethora of overhead supply, it's not really a question of if stocks will pull back again. Rather, we feel it's more a question of when there will be a correction again. Market environments dominated by extreme movements in both directions have a way of causing traders to let their guards down and become complacent. However, the most vicious reversals typically occur when the least number of market participants are expecting them. Such extreme periods in the market now require a slight change in our usual trading strategy. Specifically, rather than holding winning positions for weeks, as we would normally do in a market trending steadily up or down, we now must focus on entering trades with a shorter time horizon. Otherwise, profitable trades on either side of the market can erode too quickly. Such is the way it goes when the broad market enters into a protracted trading range.
Open ETF positions: |
Long - DBA, UNG, UUP, TLT
Short (including inversely correlated "short ETFs") - GDX, IYR
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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Disclosure: Long DBA, Long UNG, Long UUP, Long TLT, Short GDX, Short IYR