The major indices closed lower for the second straight session yesterday, but the intraday action was not as negative. The broad market gapped down on the open, initially moved a bit lower, then stabilized and drifted sideways throughout the rest of the day. This compares more favorably to Monday's losses, which resulted from steady intraday downtrends in all of the main stock market indexes. The S&P 500 fell 0.7%, the Nasdaq Composite 0.6%, and the Dow Jones Industrial Average 0.5%. The small-cap Russell 2000 slid 0.7% and the S&P Midcap 400 lost 0.9%. Like the previous day, stocks finished off their intraday lows, but still near the bottom of their trading ranges.

The marginally bright spot of yesterday's session is that turnover receded slightly. Total volume in both the NYSE and Nasdaq declined 1% below the previous day's levels. Although trading activity didn't back off much from the previous day's distribution levels, it's positive that volume did not tick higher. The presence of higher volume would have added another "distribution day" to the running count of institutional selling. Failing to improve, declining volume in the NYSE again exceeded advancing volume by more than 3 to 1. The Nasdaq adv/dec volume ratio improved slightly, registering negative by just over 2 to 1.

When the stock market gapped down yesterday morning, we sent intraday e-mail alerts to subscribers, informing them of two different actions we were taking. First, we covered our short position in the Internet HOLDR (HHH), locking in a gain of just over one point. On a technical level, we liked its breakdown below both trendline support and its 20-day EMA, but we did not want to hold the short position through Yahoo!'s earnings report after the close. As such, we made a decision to cover the short sale into weakness, rather than take the risk of holding through a major earnings report. The corrective action in HHH is annotated on the daily chart below:



Unlike most ETF families, the HOLDRS series of ETFs are not well diversified. As such, the performance of any leading stock in the sector can have a major bearing on the price of the ETF itself. In the case of HHH, Yahoo! currently represents a weighting of just over 21%. Amazon and eBay are the other heavyweights in the ETF, representing a weighting of approximately 50% between the two stocks. Based on the bullish after-hours price action in Yahoo! that followed its earnings report, our decision to cover HHH ahead of earnings worked out well. Since just about every major company will be reporting their quarterly earnings in the coming weeks, be aware of any lesser-diversified ETFs you may be holding. The respective web sites of the various ETF families provide detailed breakdowns of each fund's top holdings.

The second action we took yesterday was buying the U.S. Natural Gas Fund (UNG). In yesterday's commentary, we analyzed the setup in UNG, specifically mentioning the idea of buying it on a slight pullback. That's exactly what we did, buying UNG on its opening gap down. The trade is basically flat from our entry point, but the price action on the daily chart looks good. Yesterday's low was above Monday's low, and UNG has begun a short-term consolidation at the high. Odds are good that it breaks out above the range within the next several days. As always, we are maintaining a protective stop just in case it doesn't. Our stop is below new support of the prior downtrend line and the 50-day MA.

Yesterday, the small-cap Russell 2000 broke down below support of its intermediate-term uptrend line, causing the iShares Russell 2000 (IWM) to do the same. Our short position in IWM is currently showing a decent unrealized gain since our October 11 entry, but we need to be careful and watch the position carefully today. This is because IWM closed right at support of its 20-day EMA, which also converges with support of its prior high. The break of the uptrend line, as well as the confluence of support levels, is illustrated on the daily chart of IWM below:



If IWM shows a lot of relative strength today and holds up beyond its opening gap, we may tighten the stop in order to reduce our risk exposure. However, patience is also required because IWM could conceivably bounce modestly off the 20-day EMA, then plunge below it due to resistance of the uptrend line it just fell below. For now, our original downside price target of the 200-day MA remains.

After the close, IBM, Intel, and Yahoo! all announced solid quarterly earnings reports. The reaction had a positive effect on the Nasdaq in after-hours trading, as Intel and Yahoo! each comprise a large percentage of the index. This positions the major indices, particularly the Nasdaq, for a bullish open today. Whether or not traders sell into strength of the opening gap up will tell us a lot about the current sentiment of the market. It may be wise to lay low with new long entries this morning, at least until ensuring the Nasdaq will hold the opening gap throughout the first hour of trading.

Open ETF positions:

Long - UNG, LQD
Short - IWM

Deron Wagner is the Founder and Head Trader of both Morpheus Capital LP, a U.S. hedge fund, and Morpheus Trading Group, a trader education firm launched in 2001 that provides daily technical analysis of the leading ETFs and stocks. For a free trial to the full version of The Wagner Daily or to learn about Wagner's other services, visit MorpheusTrading.com or send an e-mail to deron@morpheustrading.com.