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iShares small-cap Russell 2000 (IWM) in a precarious position - August 24, 2010

|Includes: iShares Russell 2000 ETF (IWM), QQQ

Sparked by initial enthusiasm over some merger and acquisition activity in the market, stocks got off to a strong start yesterday morning. However, the enthusiasm was short-lived. The major indices quickly reversed, fell into negative territory in the morning, traded in a range throughout most of the afternoon, then slipped to new intraday lows into the close. The S&P 500 Index and Dow Jones Industrial Average both lost 0.4%. The Nasdaq Composite declined 0.9%. The small-cap Russell 2000 Index and S&P MidCap 400 shed 1.3% and 0.9% respectively. Each of the main stock market indexes closed at its dead low of the day.

Total volume in the NYSE was 23% lighter than the previous day's level, while turnover in the Nasdaq eased 16%. In both exchanges, trading limped in below 50-day average levels. Yesterday's lighter volume losses prevented the S&P and Nasdaq from registering a bearish "distribution day." However, the amount of institutional selling becomes less insignificant when the market is already in correction mode. Monitoring the running count of "distribution days" is more relevant when uptrending markets first start exhibiting possible signs of weakness. Conversely, when the market has already been trending lower, it often falls on its own weight, due more to a lack of buying interest than heavy selling pressure.

Although stocks have sold off in each of the past three days, and set new closing lows for August yesterday, the main stock market indexes are still holding near their intraday lows of the previous week. Furthermore, support of the mid-July lows is still holding up. Overall, the technical picture of the market hasn't changed much in recent days. However, the major indices could break down below key levels of horizontal price support with just one more day of selling. If that happens, a test of the July lows, which is also lower channel support of the four-month sideways trading range and "inverse wedge" pattern, would likely follow. Looking particularly vulnerable is the small-cap Russell 2000 Index, which is only about 2% above its July low. The daily chart of iShares Russell 2000 Index (NYSEARCA:IWM) is shown on the daily chart below:

IWM

As marked by the dashed horizontal line on the chart above, a breakdown below the August 20 low would also correspond to a break below support of the mid-July "swing lows." A test, and likely "undercut" of the early July lows, would probably occur thereafter. Our long position in the inversely correlated ProShares UltraShort Semiconductor (NYSEARCA:SSG) has a similar chart pattern to ProShares UltraShort Russell 2000 (NYSEARCA:TWM).

The daily chart of the Nasdaq 100 Index is also in a precarious situation. Although it is much further above its July lows than the Russell 2000, it would only require another decline of approximately 0.5% to cause the index to fall below the lows of its two-week trading range. Bearish momentum and selling pressure would be the likely outcome of such a move. Below is the daily chart of PowerShares QQQ Trust (QQQQ), a popular ETF proxy for the tech-heavy Nasdaq 100 Index:

QQQQ

Given the premarket weakness in the S&P and Nasdaq futures, stocks are likely to be under pressure on the open. Unless the opening gap down swiftly reverses, the key technical levels of support shown on the charts above will become violated today. Nevertheless, even if stocks break down below support of their recent trading ranges, we do not expect a lot of follow-through to the downside. In fact, we would not even be surprised to see a bullish reversal of today's opening gap down. Why? Simply because the dominant theme of the stock market over the past four months is a sideways trading range. With stocks in "no man's land," follow-through in the direction of a trend, either up or down, is the exception, rather than the norm. We hate to sound like a broken record, but that's the reality of the current environment.


Open ETF positions:

Long - TLT, DBA, UUP
Short (including inversely correlated "short ETFs") - SSG
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 DBA, Long UUP, Short SSG