The bulls were unable to build on Tuesday's strong afternoon momentum, as heavy selling across the board shut the door on any potential short-term rally. In classic bear market form, the only bounce in action yesterday came during the lunchtime doldrums, which was quickly resolved to the downside right on cue with the 2:30 reversal period. The selling intensified throughout the afternoon and into the close, as every broad market index we monitor finished at the lows of the session. The Nasdaq Composite and Nasdaq 100 erased all of Tuesday's bullish candles and more, closing down 2.3% and 2.5% respectively. This was very much the theme of the day, as the small-cap Russell 2000 and S&P Midcap 400 also retraced bullish reversal candles and dropped 3.0% each. While the S&P 500 and Dow Jones Industrial Average held the prior day's lows, the heavy selling into the close increases the odds of a morning gap down that would clearly violate the S&P 500's July 1 low, and possibly undercut the 2008 intraday low set on March 17. The S&P 500 fell 1.8%, while the Dow skidded 1.5%.

Though total volume eased by 8% on both the NYSE and Nasdaq, it came in well above the 50-day average levels, indicating heavy institutional participation on the sell side. Market internals opened in positive territory, but eroded throughout the session, with declining volume outpacing advancing volume by a significant 5 to 1 margin on the NYSE, and 4 to 1 on the Nasdaq. Advancing minus declining issues on the NYSE registered a +500 reading on the open and closed at -1,550. A decline of 2,000 issues intraday is quite substantial, and confirms the intensity of yesterday's selling.

In the June 20 issue of the The Wagner Daily, we noted money flowing out of top performing groups such as energy, and into some of the lagging groups such as biotechs. Two weeks later we finally see confirmation of this, as the leading commodity-driven stocks of 2008 came under severe distribution. Top energy ETFs Market Vectors Coal (KOL), Oil Service HOLDRS (OIH), and SPDR Oil & Gas Exploration & Production (XOP) all suffered heavy losses. Industrial metals fared even worse with vicious, wide bar selloffs in SPDR S&P Metals & Mining (XME) and Market Vectors Steel (SLX). This enabled us to cover our SLX short position into extreme weakness late in the afternoon, locking in a nice gain of 11 points. Market Vectors Agribusiness (MOO), which we pointed out as a potential short sale two days ago, plunged 5.7% yesterday. With commodity stocks coming unglued, the market is quickly losing all leadership, which will make it all the more difficult to sustain a meaningful rally off the lows over the next few months. On the positive side, the Biotech HOLDR (BBH), which we are now long, continued to show great relative strength by only retracing a small portion of the previous day's gain.

Gold, silver, and crude, along with a few select currencies, seem to be the best alternatives to owning stocks right now. Beyond these areas there is very little setting up on the long side.



Looking at the chart above, notice that the Dollar Index is breaking down from a tight wedging pattern. If the dollar resumes its downtrend in earnest, we could see a strong rally emerge in gold and silver similar to the run-up from January to March of this year.



Look for select currencies with strong technical setups to also benefit from a declining U.S. dollar. CurrencyShares Euro (FXE) is worth monitoring for a pullback entry, after reclaiming the 50-day MA and breaking the downtrend line in late June. This is an not an "official" setup, but something to keep an eye on to establish a long entry on a pullback to the uptrend line. CurrencyShares Japanese Yen (FXY) recently broke the downtrend line and is also buyable for a longer term hold on a pullback to 93.25, or on a breakout entry above the recent swing high of 94.78.

With the market at deeply oversold levels the risk/reward ratios do not favor establishing new short positions. That being said, oversold conditions can remain that way for longer than one might expect. Capital preservation is key in this highly volatile environment, so there's absolutely nothing wrong with sitting on the sidelines, preserving cash for the next low-risk opportunity that comes along. As always, remember to trade what you see, not what you think!

NOTE: The stock markets will close early, at 1:00 pm EDT on Thursday, July 3. On Friday, July 4, the markets will be closed the full day. As such, The Wagner Daily will not be published on July 4. Regular publication will resume on Monday, July 7. Enjoy the holiday with your friends and family!

Open ETF positions:

Long - BBH
Short - (none)

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.