Building on bearish momentum from the previous day's losses, stocks opened sharply lower yesterday, slid further throughout the morning session, then merely traded in a tight, sideways range in the afternoon. Never looking back after the weak start to the day, the Dow Jones Industrial Average plunged 2.5%, the S&P 500 2.8%, and the Nasdaq Composite 3.0%. The small-cap Russell 2000 and S&P Midcap 400 indices nosedived 4.0% and 3.4% respectively. Unlike most sessions in recent weeks, stocks did not experience a sharp intraday trend reversal after the open. Each of the main stock market indexes closed near its worst level of the day.
Total volume in the NYSE ticked 18% higher, while volume in the Nasdaq rose 11% above the previous day's level. The broad-based losses on higher volume caused the S&P and Nasdaq to register another bearish "distribution day." Clearly, the stock market is feeling the weight of heavy selling amongst mutual funds, hedge funds, and other institutions. As we said yesterday, "a healthy market can absorb a couple 'distribution days' within the course of its uptrend, but the presence of four or more days of higher volume selling typically precedes a significant correction in the broad market." Yesterday was the fourth "distribution day" within the past two weeks. Market internals were also atrocious. In both the NYSE and Nasdaq, declining volume destroyed advancing volume by a margin of approximately 25 to 1. This means the selling was broad-based, weighing heavily on virtually every industry sector.
In yesterday's commentary, we reminded subscribers of the large "inverse wedge" pattern dominating the daily chart of the S&P 500, and suggested the pattern favored at least a short-term move lower. Key resistance of the June 2010 highs, which the S&P and Nasdaq were unable to move above, further supported the notion. But now, after just two sessions of heavy selling, the S&P 500 has already retraced down to support of its 50-day moving average. This already represents a substantial correction from the recent highs. Therefore, let's take a look at two ETFs with relative strength, which may be provide low-risk pullback buy entries within the next few days:
PowerShares Agriculture Fund (NYSEARCA:DBA), a commodity ETF comprised of a basket of agricultural futures contracts, has pulled back to support of its 20-day exponential moving average, with additional support of its prior breakout level just below. On August 2, we sold our position in DBA at $26.20, locking in a very large gain on the trade when it hit our profit target. However, it has remained on our radar screen since then, as we've been waiting for a pullback, which is happening right now. The setup is annotated on the daily chart below:
With DBA now kissing its 20-day EMA, there are two potential entry points for this trade. The first is a rally above yesterday's (August 11) high of $25.68. If DBA gaps above that price, it likely means the pullback to the 20-day EMA will be very short-lived before the ETF resumes its uptrend. Another possible entry point is an "undercut" of yesterday's low and the 20-day EMA that snaps back above the 20-day EMA the following day. Regular subscribers know the "undercut" is one of our preferred methods for trade entry, especially in a choppy market. Therefore, we'd like to see DBA slip below yesterday's low in today's session, then snap back tomorrow. Because it's a commodity ETF, one nice thing about DBA is its low correlation to the direction of the overall equities markets.
Market Vectors Brazil Small-cap (NYSEARCA:BRF) has gapped down to "undercut" its 20-day EMA, while it tests support of its multi-month uptrend line. We'd like to see a narrow-ranged candle in today's session, then a rally above the high of today in tomorrow's session. Such price action would be a decent pullback entry point, though BRF could fall a bit more, down to support of its breakout level. The daily chart of BRF is shown below:
Although it's a breakout play, not a pullback entry, iShares 20+ Year T-Bond (NYSEARCA:TLT) is looking good. The daily chart is shown below:
Our model ETF portfolio has been long TLT since late June, collecting monthly dividends twice since then, and we continue to hold in anticipation of further price appreciation. With a solid base of support, as well as its 20 and 50-day moving averages below, TLT is now testing resistance of its short-term, hourly downtrend line from the July 1 high. If TLT rallies above yesterday's high, it should lead to another leg higher over the next week. A close above the $102.03 level would also represent a fresh, 52-week closing high.
Open ETF positions: |
Long - TLT, UUP, UNG
Short (including inversely correlated "short ETFs") - DZZ
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 email@example.com.
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Disclosure: Long TLT, Long UUP, Long UNG, Short DZZ