Bearish momentum from the market's September 4 plunge spilled over into the morning of last Friday's session, but stocks later stabilized and reversed, enabling the major indices to finish with mixed results. The S&P 500, down 1.5% at its morning low, rallied to finish with a 0.4% gain. The Dow Jones Industrial Average similarly bounced 0.3%. The Nasdaq Composite settled with a 0.1% loss, but the index was actually down 1.9% at its worst level of the day. The small-cap Russell 2000 was unchanged, as the S&P Midcap 400 advanced 0.4%. After reversing from near-term "oversold" conditions in the morning, each of the main stock market indexes closed the day near its intraday high. Nevertheless, all the major indices registered sharp losses for the week.

Total volume in both the NYSE and Nasdaq slipped 4% below the previous day's levels. Still, trading remained above average levels for a second straight day. Market internals were very ugly in the beginning of the day, but improved substantially as the day progressed. By the closing bell, advancing volume in the NYSE had narrowly exceeded declining volume by a margin of 3 to 2. The Nasdaq adv/dec volume ratio remained marginally negative.

After nearly a month of choppy, range-bound trading, the broad market decisively broke lower, below key support levels, on September 4. While this may have been bad news for traditional "buy and hold" investors, it was good news for astute short- and intermediate-term traders who focus on profiting from market trends in either direction. Stocks followed up that major sell-off by closing flat to marginally higher the following day (last Friday). Going into today, this sequence of price action initially positioned the main stock market indexes for a bounce into new resistance of their prior lows from August, which they fell below last week. But just when the stock market was about to present us with ideal short-sale opportunities, the Fed curiously announced, over the weekend, that troubled mortgage lenders Fannie Mae and Freddie Mac will be taken over by the U.S. government. Upon reacting to this interesting news, the S&P and Nasdaq futures markets rocketed nearly 3% higher on Sunday evening, and have been hanging out around those levels overnight. Unless something substantially changes over the next few hours, all the major indices will open 2% to 3% higher today.

In last Friday's commentary, we said we would analyze the charts of the main stock market indexes today, in order to determine the most ideal short entry points in the coming week. However, as of now, the major indices are already poised to open well above their resistance levels of the August lows. The S&P and Dow are even positioned to open above their 20 and 50-day moving averages. Obviously, the Fed pretty much threw a wrench in our clear plan, and there was no way to anticipate such action.

Given the circumstances, it would now be a moot point to spend much time looking at resistance levels and potential short entry points before seeing the outcome of today's session. The annotated daily chart of the S&P 500 explains why this is the case:



Will last week's plunge turn out to be a failed breakdown, or will today's pre-market enthusiasm vanish just as quickly as it appeared? Who knows? The only thing we know for certain is we're forced to once again revert to "wait and see" mode, at least for a day or two. Fortunately, we only have two open ETF positions, one bearish (SMN) and one with little correlation to the direction of the stock market (FXE). Given the situation, we're glad to have been waiting for a bounce after last week's breakdown before deciding to get more aggressively short.

Frankly, I don't see how a financial disaster of such proportions as Fannie and Freddie can be considered good news by the market, as the Fed is now committed to putting as much as 100 billion dollars into each entity. Nevertheless, I've learned over the years that the market doesn't care about my opinion, or anyone else's for that matter. That's why I manage my hedge fund under the mantra of trade what I see, not what I think! If the market manages to hold on to today's opening gap throughout the entire day, we have no problem relinquishing our near-term bearish bias. But the "smart money" will undoubtedly want the market to prove it by waiting to see whether today's opening gap is just a knee-jerk reaction that will quickly fade away, or if it could be the start of something much more positive, at least in the near- to intermediate-term.

As a final thought, if you got stuck with any losing long positions because of last week's sell-off, you may want to view today's opening gap as a gift, and sell into strength. If both the opening gap and your long positions hold firmly through the final minutes of trading, you can always re-enter, and with much less risk. As for entering new short positions, all bets are off until we see the final outcome of today's session. We'll re-assess with our updated thoughts and potential ETF plays in tomorrow's commentary, but we're going to play it conservatively in "wait and see" mode until then.

Open ETF positions:

Long - FXE, SMN
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.