OVERVIEW
Semiconductors Dragging The Market Down

Yesterday was a challenging day for the market, with semiconductor stocks taking a sharp hit, led by ASML and Nvidia (NVDA), which dragged down the broader indices.

The pullback followed reports that the Biden administration is considering country-specific caps on sales of advanced AI chips from Nvidia and other U.S. companies. This would tighten restrictions beyond China, as the U.S. evaluates the security risks of global AI development.

For Nvidia, this news delivers a significant blow. With a market cap exceeding $3.2 trillion, the company is a titan in the semiconductor space. In 2023, about a third of its revenue came from China, and when including Taiwan, nearly half of its business relies on the region. While the Biden administration's focus on AI safety and national security is understandable, the immediate impact was felt across U.S. equities, particularly the Nasdaq and S&P 500 (SPY), both of which are heavily weighted by Nvidia.

The Markets Remain Strong

Although yesterday was a tough day for those of us with exposure to the semiconductor and tech sectors—particularly in what has been the strongest area of the market recently—the demand for chips remains incredibly strong. When the Biden administration first implemented sweeping chip regulations on China, Nvidia quickly adapted by redesigning its AI offerings to keep selling in that market. This shows how difficult it is to truly contain expansion into such a large, economically important region.

For those who held Nvidia shares, yesterday's pullback may have shaken you out of your position, but this is not something to be overly worried about. Pullbacks happen, and it’s nearly impossible to predict external events like these.

From a broader perspective, the market is still resilient. All major indices are holding their daily 10-EMA, and much of the early session losses were retraced by the close. The big question moving forward is whether the upward momentum we've been riding can continue. Keep an eye on how the market digests this news in the coming days, but overall, the underlying strength remains intact.

Nasdaq

The Nasdaq took the hardest hit yesterday due to the sharp decline in the semiconductor sector, mainly driven by Nvidia’s significant 9.4% weighting in the QQQ, just shy of Apple’s 9.8%. Despite Nvidia's slide, the sell-off in the QQQ was largely contained, as Apple bucked the trend, closing solidly in the green and continuing its recent breakout.

This distinction is key—it suggests that this isn’t the start of a broader decline in the QQQ's major holdings, but rather a specific event centered on Nvidia. For now, it seems more like an isolated black swan event rather than a prolonged downturn that could drag the entire market lower.

Technically, the QQQ remains strong. Yesterday, it found support at its rising 10-EMA, preventing a deeper breakdown that would have threatened the recent breakout from its multi-month base. Additionally, there was a gap between $493.50 and $495.80 that needed filling, likely contributing to the increased selling pressure.

Today, the focus is on whether the QQQ can hold above the 10-EMA and move sideways, calming market sentiment and reaffirming strength. A drop below this level, however, could signal deeper weakness, raising concerns as we approach the presidential election and its potential market impact. Holding the 10-EMA is critical to avoiding further deterioration in momentum.

S&P Midcap 400

The midcaps are exhibiting signs of a "shooting star" pattern, as identified by candlestick theory, which features a long upper shadow. This pattern serves as a bearish reversal signal, suggesting that buyers may be losing momentum and that sellers could soon take control, pushing prices lower.

Traders typically seek confirmation after a shooting star, waiting for the next candlestick to determine if the price declines. A decline may signal a potential sell or short opportunity, while a rise could indicate that the shooting star was a false signal, allowing the bullish trend to continue.

Adding to the concern is the high volume from yesterday's session. Combined with the price action indicating strong selling pressure, this creates a troubling scenario. The volume recorded was the highest in over two weeks, suggesting a significant shift in market sentiment. Such a combination typically signals that sellers are gaining control, which could lead to further declines in the midcaps.

It's absolutely critical for the MDY to either hold sideways and form several inside days, allowing the rising 10-EMA to catch up, or for the selling pressure to cool off. It’s especially vital that the 10-EMA does not get undercut. While a test of the 10-EMA is likely in the near term and could be healthy, it’s not what you would expect to see following the significant breakout the MDY experienced just three sessions ago.

Russell 2000

The small caps also exhibited signs of a shooting star, though not as pronounced as that of the MDY. The Russell 2000 encountered significant resistance at around $225.50, a dense supply level that will require effort to break through.

The IWM is in a similar situation, where the key focus should be on sideways action, ideally for a few days, before attempting to overcome the overhead resistance and breaking above the supply zone created during the consolidation in late July.

While the prevailing trend remains positive following the recent breakout in the IWM, this period will serve as a true test. It’s likely to introduce considerable volatility to your portfolio if you’re not vigilant about position sizing and risk management.

DAILY FOCUS
Overtrading: The Biggest Trap in This Market

As we look at the current market, it’s important to stay grounded, especially with the recent signs of a shooting star in the midcaps (MDY) and small caps (IWM). For now, it makes sense to shift into a risk-off mindset. While it’s tempting to jump into new trades, we need to be mindful that the market is showing some signs of weakness.

Instead of overtrading, let’s focus on tracking the stocks that are really standing out. We’ll keep an eye on the relative strength leaders and see how recent breakouts are holding up. This will help us figure out which stocks still have momentum and which ones might be running out of steam.

There’s no reason to panic or start raising cash aggressively, especially if the stocks we already own are performing well. However, we should be cautious about opening new long positions right now, as the chances of success might be lower if we’re heading into a deeper pullback.

From a risk/reward perspective, our best bet is to concentrate on the positions we already have that are working. We can think about raising our stop-loss levels to protect our gains or even adding to the stocks that are showing strong performance. This way, we can keep our focus on the winners without getting caught up in overtrading.

A great example of this is Calumet, Inc. (CLMT), a stock we added long exposure to on October 3rd, during its major breakout. After that big move, CLMT went sideways for several days. Yes, it pulled back yesterday to test the rising 10-EMA, but here’s the kicker: it bounced right off that level on high volume and pushed to new highs.

This was a perfect opportunity for us to add to our position instead of panicking and selling during the pullback. It found support exactly where we wanted it to, showing strong relative strength. Scaling up on this winning trade is much more efficient than chasing new long positions, especially when the chances of getting stopped out are higher.

Remember, it’s all about preserving our capital and being ready for when the market gives us clearer signals. Staying patient and focused will help us navigate these waters more effectively.

WATCHLIST
The Few On Breakout Watch

ZETA: Zeta Global Holdings Corp.

• Zeta (ZETA) has been gaining some impressive momentum in recent months, steadily rising above its 10 and 20-day EMAs since breaking out into a Stage 2 rally back in early to mid-July.

• Recently, ZETA has been trending sideways, squeezed between overhead resistance at $32.20 and the rising daily 10 EMA, which has been building higher lows. It looks like it's gearing up for a continued march toward the $40 mark.

• We’ll be keeping a close eye on ZETA to see if it can generate high relative volume on a potential breakout candle. Watching the 5-minute opening range high will help us identify an entry point.

• Given the choppier market conditions, if we decide to take a position, it would make sense to start with half-sized risk to limit our downside. This way, we can manage our exposure while still participating in what could be a solid opportunity.

DUOL: Duolingo, Inc.

• One of the standout technology stocks in recent months has undoubtedly been Duolingo (DUOL). The stock is currently trending sideways, finding support on the rising 10-EMA as it builds higher lows, setting the stage for a potential leg higher.

• Typically, we prefer to see less extension from the 50-EMA, with DUOL currently at a 7x multiple. Stocks usually don’t stretch more than 8-10x from their 50-EMA. However, given the wild market conditions we've been experiencing and DUOL's impressive strength, it's essential to keep an eye on these extended stocks—after all, they can remain extended for quite some time.

• Similar to ZETA, if we decide to take an entry on DUOL, we’ll do so with half-sized risk to manage our exposure.