For the third time within the past four sessions, morning strength faded in the afternoon, causing the major indices to finish near their intraday lows. The S&P 500, Nasdaq Composite, and Dow Jones Industrial Average each lost 0.1%, after giving up early gains of 0.3%, 0.5%, and 0.2% respectively. Small and mid-cap stocks bounced from their positions of relative weakness, causing the Russell 2000 to gain 0.4% and the S&P Midcap 400 to advance 0.1%. Prior to the middle of this month, the major indices had a tendency to recover from morning weakness and finish near their intraday highs. However, we have seen the opposite pattern in three out of the past four trading days. Although the S&P and Dow remain indecisive and range-bound, this tells us the bears may be starting to gain the upper hand. In the Nasdaq, the weakness has been more apparent.

Total volume in the NYSE declined by 12%, while volume in the Nasdaq was 11% lighter than the previous day's level. Despite the losses in the S&P and Nasdaq, market internals finished slightly positive. In both exchanges, advancing volume exceeded declining volume by a ratio of 1.2 to 1. Obviously, the ratios were much higher in the morning. It's positive that turnover declined as stocks reversed to the downside intraday, but bear in mind that volume is likely to continue declining until the holiday season has concluded. Next Monday, the stock market is closed in observance of Christmas Day, and volume will probably dry up over the next two sessions as well. Traditionally, the week between Christmas and New Year's Day is also rather slow, so we would not be surprised if the major indices remain stuck in a range until the beginning of the new year.

If you were positioned in any of the ProShares ETFs going into yesterday morning, you may have been a bit surprised to see each of them gap down significantly on the open. Despite a relatively flat open in both the Nasdaq 100 and the S&P Midcap 400 indices, our long positions in the UltraShort QQQQ (QID) and the UltraShort S&P Midcap (MZZ) each opened significantly lower. After researching the issue, we realized that the large discrepancies were the result of annual dividend and capital gains distributions in the entire family of ETFs. Just like an individual stock, all ETFs are required to distribute income payments, while some distribute capital gains as well. When that happens, the price of the ETF is adjusted lower to compensate for the subsequent cash distribution. However, most ETFs pay dividends on a quarterly basis, whereas the new ProShares ETFs are currently paying on an annual basis. The difference is that the price adjustment in the price of the ProShares ETFs is much more significant and noticeable than with an ETF that makes regular quarterly distributions.

When you are short an ETF that makes a dividend distribution, the price of the ETF will gap lower by the amount of the distribution, but the amount of the dividend distribution will be debited out of your brokerage account. The net result is no change in your bottom line. Given that our QID and MZZ positions are inversely correlated to their respective market indices, buying them is basically the same as selling short QQQQ or MDY (albeit with 2 to 1 leverage). As such, we assumed these ETFs would gap higher, not lower, when they traded ex-dividend yesterday. We would then expect the usual debit of the dividend payment from the brokerage account. Seeking clarification, we contacted ProShares and were informed that, even though they are inversely correlated ETFs, dividend payments are still credited, rather than debited, which explains why they gapped down yesterday. When dividends are distribution on December 27, they will be equal to the per share amount of the discrepancy in trading price yesterday, but it artificially skews our stop prices and profit/loss for our open positions in the meantime. MZZ technically hit our stop price because of the ex-dividend adjusted price, but no downside occurred because the amount of the gap down will be paid to all shareholders next week.

In the four years that we have been analyzing ETFs and providing detailed trade setups, this is the first time where the ex-dividend adjusted price of an ETF was ever significant enough to make a difference in our stop or target prices. To deal with this unusual scenario, we have adjusted our stop and target prices to reflect the dividend payment, and will subsequently include the amount of the dividend distribution in our "official" performance report when the trade is closed. Going into the new year, we have also realized the need for a new set of guidelines that account for the price adjustments on ETFs that happen to distribute dividends and/or capital gains while we are positioned in them. Otherwise, our performance reporting will become inaccurate as more ETFs are introduced. Regular subscribers will be notified as soon as the new guidelines have been added into our User Guide.

As for the broad market analysis, there's not much new to report going into today. The Nasdaq remains below its primary uptrend line that it broke on Tuesday, while both the S&P and Dow are holding near their highs. We will provide an updated view on the industry sector performance in the beginning of next week. Like we mentioned, turnover is likely to decline in the coming days, and stay that way until the new year begins. As such, now is a good time to put together or revise your trading plan for the new year.

NOTE: The U.S. stock markets will be closed on Monday, December 25, in observance of Christmas Day. The Wagner Daily will not be published that day, but regular publication will resume on Tuesday. Have a great holiday weekend with your friends and family!

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.