As it did two days prior, the broad market sold off last Friday morning, but this time stocks failed to recover much of their losses in the afternoon. Both the S&P 500 and Nasdaq Composite slid 1.2%, while the Dow Jones Industrial Average lost 1.1%. The small-cap Russell 2000 continued to show relative weakness by dropping 1.8%. The S&P Midcap 400 was lower by 1.0%. Each of the major indices closed in the bottom third of their intraday ranges.

Turnover rose in both exchanges, causing both the S&P and Nasdaq to register their second "distribution days" within the past three sessions. Total volume in the NYSE surged 30% above the previous day's level, while volume in the Nasdaq increased by 5%. Last Thursday, stocks snapped back from their higher volume losses of July 18, but that day's gains were on lighter volume. Then, the major indices gave up all those gains on Friday, once again on higher volume. The volume patterns in the broad market have become negative over the past several days, so be on the lookout for further instances of institutional selling in the coming week. If the S&P and/or Nasdaq suffer two or more days of distribution this week, leading stocks will have difficulty withstanding any further selling pressure. So far, however, leaders such as Research In Motion (RIMM) and Apple (AAPL) are holding up well. This is a positive sign for the stock market, especially the Nasdaq.

On July 18, the S&P 500 tested key support of its prior downtrend line on an intraday basis, but reversed to close above it. It subsequently tested that same support level last Friday, but closed right at the pivotal level. Since the 20-day EMA also converges with the prior downtrend line, last Friday's low is an important level the index needs to hold going into today:



If the S&P happens to fall below the July 20 low, the 50-day MA, presently at the 1,520 level, may catch it. However, notice how many times the index has tested support of the 50-day MA over the past six weeks. Each subsequent test of the 50-MA weakens the support it provides, so it would be dangerous to blindly assume the S&P will once again bounce off its 50-MA. Nevertheless, aggressive short selling is not recommended unless the S&P at least closes below its prior low from July 11. Such a move would confirm the recent breakout to a new high as having failed, while the "lower low" would represent a clear sell signal.

Like the S&P 500, the Nasdaq Composite also closed just above a key support area that it tested on July 18:



The prior high of July 9, around 2,672, marks the current support in the Nasdaq. A few points below that level and last Friday's low is support of the 20-day EMA. If that level breaks, major support will be found at the prior highs from mid-June (the dashed horizontal line on the chart above).

For now, one might consider avoiding new trade entries on either side of the market until we see how both the S&P and Nasdaq follow-up last Friday's closing prices at key support levels. Focus on individual sectors with relative strength or weakness, rather than the more common (and less predictable) broad-based ETFs. As with last week, surprises on the corporate earnings front is likely to have the greatest bearing on the market's direction in the coming week.

Open ETF positions:

Long - GDX, PBW, FXC, and IBB (closed INP for nice gain last Friday)
Short - RKH

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.