Stocks concluded the week with a round of substantial declines last Friday, breaking some key technical support levels in the process. The major indices opened slightly lower, then trended down throughout the rest of the day. The Nasdaq Composite lost 1.1%, the S&P 500 1.3%, and the Dow Jones Industrial Average 1.4%. Small-caps showed relative strength, as the Russell 2000 Index fell just 0.6%. The S&P Midcap 400 Index shed 1.0%. All of the broad-based stock market indexes closed near their intraday lows.

Volume in both exchanges rocketed higher, but the surge was deceiving, as it was primarily driven by the annual rebalancing of the Russell. Total volume in the NYSE increased 63%, while volume in the Nasdaq rose 69% above the previous day's level. Once per year, underperforming stocks in the small-cap Russell indexes are replaced with better candidates. This typically causes volume to jump higher in the last hour of trading, as the various small-cap index funds are required to adjust their portfolios to match the new holdings. Throughout most of the day, turnover was actually on pace to be equal or slightly below the previous day's levels, so the end-of-day Russell volume boost was the whole reason for the higher turnover. Even though higher volume matched the losses, the S&P and Nasdaq really did not register another "distribution day."

Friday's weakness caused the S&P 500 to close below its 50-day moving average for the first time since March 30. Since the beginning of June, the index has tested support of its 50-day MA several times on an intraday basis, but this was the first time it closed below it. While this occurrence is technically bearish, the S&P only closed three points below the 50-day MA -- not so far that it could not easily snap back above it today. It's also notable that all the other major indices still remain above their 50-day MAs. Thanks primarily to the recent strength in the Semiconductor Index ($SOX), The Nasdaq 100 is still just a few points below its multi-year high and is even holding above its 20-day EMA. With this type of divergence in the market, we're looking for one of two possible scenarios to occur that should help clear up some of the market's indecision. To confirm the recent bullish environment, a clear breakout to new highs in the Nasdaq 100 and/or Nasdaq Composite should do the trick, as it would also pull the S&P back above its 50-day MA:



Conversely, the balance of power would shift to the bears if the S&P 500 not only stays below its 50-day MA, but breaks down below its prior lows from earlier this month. As you can see on the daily chart below, the next line of major support in the S&P is at the 1,490 level, about 0.8% below last week's close.



If the S&P holds above its June low, it could still move back above its 50-day MA without a great degree of difficulty. However, a break below 1,490 would likely trigger a round of institutional selling that results in a high-momentum downward move. The "double top" formation in the S&P would also be confirmed.

With the S&P and Nasdaq showing such divergent patterns, this is not the time to be placing big bets on either side of the market. Instead, consider balancing your positions between the long and short side. When the broad market eventually makes its next definitive move, one can quickly close the positions on the wrong side, while letting the profits accumulate on the right side. The other alternative, which is not a bad one at all, is to simply wait in cash.

Open ETF positions:

Long - SMH, SDS
Short - EWO, XME

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.