Watching for Further Market Weakness

Downward momentum from the previous day's selloff caused stocks to move lower last Friday morning, but the major indices stabilized and recovered in the afternoon, eventually settling near unchanged levels. The Nasdaq Composite eked out a 0.1% gain, but both the S&P 500 and Dow Jones Industrial Average closed 0.1% lower. Small and midcap stocks showed relative strength, enabling the Russell 2000 and S&P Midcap 400 indices to advance 0.5% and 0.3% respectively. Total volume in the NYSE declined by 14%, while volume in the Nasdaq was 9% lower than the previous day's level. In both exchanges, advancing volume fractionally exceeded declining volume.

Despite the small gain in the Nasdaq Composite, the less diversified Nasdaq 100 Index still lost 0.3%. The decline caused our long position in the UltraShort QQQ ProShares [QIDQID] to gain another 1% and close at its highest level since January 3. Not only is QID building a base above its 50-day MA, but it also closed last Friday above its primary downtrend line that has been in place since the high of July 2006:

As long as the Nasdaq 100 remains below last Friday's high, QID will remain above new support of its prior downtrend line illustrated above. If it does, bullish momentum should carry QID higher in the short-term. Our price target on the swing trade is just below resistance of the prior high from November 3, around $58.35.

Although the first three weeks of the month have been quite erratic and indecisive for the Nasdaq Composite, the index may finally be positioned to make a solid move (downward) out of its ten-week trading range. Let's take an updated look at its daily chart:

On January 11, the Nasdaq Composite broke out above its sideways range and closed at a new six-year high. But only four days later, the index failed the breakout by falling back down to the middle of its prior range. Support of the 50-day MA subsequently caught the Nasdaq again, prompting the index to make another run at breaking out, but it was unable to overcome resistance of the prior high at the 2,470 level (the dashed horizontal line). Overhead supply created from the sharp selloff of January 25 now makes it even more difficult for the Nasdaq to recover back above the 2,470 resistance. Given that the Nasdaq has closed four of the past five sessions just below its 50-day MA, it also won't take a lot of additional selling pressure to trigger a swift breakdown below the range.

The daily charts of the S&P 500 and Dow Jones Industrial Average are both different than the Nasdaq, but they nevertheless had failed breakouts last week. Just at the Nasdaq did on January 11, the S&P 500 broke out and finished at a fresh six-year high on January 24. However, the Nasdaq's 2,470 resistance level that triggered the January 25 selloff had an equally negative affect on the S&P as well. The S&P immediately failed its breakout and finished last week just above its 50-day MA. Be prepared for another test of the 50-MA in the coming days. Though the 50-day MA is always an important support level, failed breakouts that precede a test of the 50-MA increase the odds of a breakdown below the 50-MA support:

The Dow has a very similar chart pattern as the S&P, as it broke out to a new (all-time) high on January 24, failed badly on January 25, then closed last week just above its 50-day MA:

Given the unpredictable and whippy nature of the broad market throughout most of January, we are not yet feeling very confident that the major indices will each crack their 50-day MAs in the coming week, but we are equally reluctant to believe they will rally back up to new highs. Presently, we are lightly positioned with shares of only QID and GLD (StreetTRACKS Gold Trust), both of which are showing unrealized gains. If the S&P and/or Dow firmly break last week's lows and their 50-MAs, we will probably initiate new short positions, but we are currently taking a "wait and see" stance. On the long side, we were stalking the Biotech HOLDR (BBH | Quote | Chart | News | PowerRating) and Internet HOLDR (HHH | Quote | Chart | News | PowerRating) for possible entries, but both ETFs finished last week below their breakout levels. Therefore, we will pass on buying these ETFs unless they immediately stabilize and move back above their pivots. Be prepared for a lot of volatility in the last several days of the month, and remember to trade what you see, not what you think!

Open ETF positions:

Long QID, GLD (regular subscribers to The Wagner Daily receive detailed stop and target prices on open positions and detailed setup information on new ETF trade entry prices. Intraday e-mail alerts are also sent as needed.)


Deron Wagner is the head trader of Morpheus Capital Hedge Fund and founder of Morpheus Trading Group (morpheustrading.com), which he launched in 2001. Wagner appears on his best-selling video, Sector Trading Strategies (Marketplace Books, June 2002), and is 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. He is also a frequent guest speaker at various trading and financial conferences around the world. For a free trial to the full version of The Wagner Daily or to learn about Deron's other services, visit morpheustrading.com or send an e-mail to deron@morpheustrading.com .