After a day of tight, sideways consolidation, the major indices finished slightly higher yesterday. However, an intraday tug-of-war between the bulls and bears kept traders on their toes, and caused stocks to finish well off their highs. The broad market opened lower, reversed into firmly higher territory by mid-day, then drifted back down in the afternoon. The Nasdaq Composite gained 0.4%, the S&P 500 0.2%, and the Dow Jones Industrial Average 0.1%. Scoring its seventh consecutive advance, the small-cap Russell 2000 rose 0.4%. The S&P Midcap 400 edged 0.1% higher. A bounce in the final thirty minutes of trading prevented the main stock market indexes from closing near their lows of the day. Instead, stocks settled near the middle of their intraday ranges.

Total volume in the NYSE surged 24%, while volume in the Nasdaq rose 16% above the previous day's level. Although higher volume on an "up" day is typically a positive sign, this was not necessarily the case yesterday. Because most of the increased volume occurred during the afternoon sell-off, the higher turnover was actually a sign of "churning." This occurs when institutions stealthily sell into strength, after a protracted rally, causing volume levels to spike higher and prices to remain little changed. Market internals were marginally positive. In both the NYSE and Nasdaq, advancing volume exceeded declining volume by a ratio of less than 2 to 1.

In our March 8 commentary, we suggested the broad market would likely continue higher until at least the S&P 500 caught up to the Russell 2000, S&P Midcap, and Nasdaq at testing resistance of its January 2010 highs. At that level, we said overhead supply from the January highs could spark a short-term correction in the broad market, which would prompt us to "consider lightening up and/or tightening stops on long positions." Not surprisingly, yesterday afternoon's distribution (churning) came into the market as the S&P 500 SPDR (SPY), a popular ETF proxy for the S&P 500 Index, came within just 0.1% of its January high. This is shown on the daily chart of SPY below:



Less obvious than the test of the January high in the S&P 500 is resistance of that high also correlated to the CBOE Volatility Index ($VIX) coming into its prior low from January 2010. Widely known as the "fear index," the $VIX gives us a visual representation of the level of investor complacency in the market. A lower reading indicates a low level of fear, which is generally a contrary indicator of future market direction. On the chart below, notice how the correction that began in January kicked into gear as the $VIX dropped to the same level its presently trading at:



The $VIX trading at the same level that started the January correction in the broad market is indeed a warning sign to aggressive bulls. Yet, despite the S&P 500 contending with key resistance of its January 2010 high and the $VIX testing its January low, there's no reason to panic and suddenly start selling everything today. After all, yesterday was the first recent display of distribution the market has exhibited. Nevertheless, one might now consider trailing tighter stops on existing long positions, especially those that have been lacking relative strength on the way up. If the broad market indeed enters into a correction from current levels, the healthy pullback will be welcomed, as it will create fresh, lower-risk buying opportunities in strong ETFs.

Yesterday, we made a judgment call to lock in profits on iShares U.S. Technology Sector Index (IYW), which we bought last week. Compared to the Nasdaq, IYW has lacked substantial upside momentum since entry. As such, we were not interested in holding through a potential pullback in the broad market. However, we remain long both iShares Xinhua China 25 (FXI) and KBW Capital Markets SPDR (KCE). FXI does not necessarily have a close correlation to the U.S. markets, while KCE has just broken out above resistance of a five-month downtrend line. We're also holding just a half position of KCE, which we may add to on a pullback to support. Yesterday, we also entered a new position in Market Vectors Gold Miners (GDX). Though it has not yet broken out above the highs of its five-day range, yesterday morning's gap down to the 50-day MA provided a low-risk entry point, after GDX subsequently reversed to a new intraday high at mid-day. Buying pullbacks in commodity-related ETFs is often more effective than buying breakouts.

Open ETF positions:

Long - FXI, KCE, GDX
Short (including inversely correlated "short ETFs") - (none)

Deron Wagner is the Founder and Head Trader of both Morpheus Capital LP, a U.S. hedge fund, and MorpheusTrading.com, a trader education firm.