Stocks followed up the previous day's bearish reversal with a narrow-range day of choppy, noncommittal trading that caused the major indices to finish with mixed results. The Dow Jones Industrial Average eked out a gain of 0.1%, but the Nasdaq Composite fell 0.7%. The benchmark S&P 500 Index was lower by 0.2%. Small and mid-cap stocks also showed divergence with one another. The Russell 2000 advanced 0.5%, as the S&P Midcap 400 lost 0.7%. The S&P 500 settled just above the middle of its intraday range, while the Nasdaq Composite was closer to the bottom third of the day's range.

Total volume in both the NYSE and Nasdaq ticked 2% higher than the previous day's levels, causing the Nasdaq to register another bearish "distribution day." The slightly positive close in the Dow, however, prevented the S&P 500 from receiving the same label. The Nasdaq has now registered four days of higher volume losses in recent weeks. Typically, the presence of more than three such days of institutional selling is enough to trigger a wave of downward momentum. In mid-May of 2008, the Nasdaq suffered four "distribution days" over a short period that eventually triggered the June - July sell-off. The potential counterpoint, however, is that three of the four recent days of "institutional selling" have occurred on much lighter than average volume. Regardless, the warning alarm created by four "distribution days" is enough to put the bulls on high alert for a potentially sharp sell-off.

One industry sector that's been exhibiting pretty clear relative weakness to the broad market is Basic Materials. This week's pullback to near the bottom of the broad market's recent range caused the Basic Materials ETFs to already drop to test their July 2008 lows. For weeks, the sector has been consolidating near its lows, largely ignoring rally attempts in the broad market. As such, Basic Materials will likely be one of the sectors to lead the fall to new lows if the major indices begin to head back down to test their July 2008 lows. On the weekly chart of S&P Materials SPDR (XLB) below, we've circled the bearish consolidation at the lows, which has been in effect for two months:



A break below the $37.50 to $38 level in XLB would present a valid, intermediate-term short entry in XLB. But for those of you who trade non-marginable accounts, such as an IRA, or if you simply having trouble locating shares to sell short, consider buying the inversely correlated UltraShort Basic Materials ProShares (SMN). Like the entire "UltraShort" family of ETFs, SMN moves in the opposite direction of the underlying sector, and at a ratio that is double the percentage movement of the actual sector. Thanks to subscriber Dennis for yesterday's heads-up on SMN. On its daily chart below, notice how SMN just rallied above its 200-day MA, and is poised to break out above its prior high from early August. At this time, a buy entry point would be over yesterday's high of $40.17:



Yesterday, the S&P 500 and Dow Jones Industrial Average dipped below their 50-day moving averages (MA) on an intraday basis, but both indexes reversed to close firmly above their key levels of support. The Nasdaq Composite also probed well below its 50-day MA, but only managed to close the session right at its 50-day MA. Overall, yesterday's action did little to change the technical picture of the broad market. The major indices are still oscillating in range-bound channels, making it equally challenging for bulls or bears to profit from any type of trend that attempts to develop. If there's a silver lining on the market's cloud of indecision, it's that the relatively weak Nasdaq could easily break down to close below its 50-day MA. If it does, the rest of the main stock market indexes would likely follow, perhaps all the way down to test their July 2008 lows. For technical traders such as ourselves, this would be good news because at least the short and intermediate-term trends would become more clearly defined, even if the trends are "down." Remember to trade what you see, not what you think! Patience and discipline pays big dividends right now.

Open ETF positions:

Long - IYH
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.