As anticipated, the 200-day moving average of the S&P 500 "did its thing" yesterday, triggering a late-day bounce in the benchmark index. Volatility was high, as the S&P probed below its 200-day MA several times throughout the session, but buying programs in the final thirty minutes of trading lifted the major indices firmly higher. Blue-chips led the way, enabling the Dow Jones Industrial Average to gain 1.1%. The S&P 500 climbed 0.7%. The Nasdaq showed relative weakness, closing only 0.3% higher. The small-cap Russell 2000 and S&P Midcap 400 indices lagged behind as well, advancing just 0.2% and 0.3% respectively. All of the major stock indexes finished near their best levels of the day.

Total volume in the Nasdaq rose 6% above the previous day's level, helping to confirm yesterday's gains, but overall volume in the NYSE declined 9%. For most of the day, market internals were quite negative. During the last thirty minutes, the ratios dramatically improved, with advancing volume marginally exceeding declining volume.

It was bullish that the S&P 500 undercut its 200-day MA in the morning, running stops, then rallied sharply into the close. It was clearly indicative of bottoming action, but it's impossible to know how far the bounce will carry us. One scenario is that the S&P will retrace a third to half of its recent losses, then plummet back down to new lows. This is what happened when then the S&P last tested its 200-day MA in May of 2006. The other possibility is that a legitimate, sustainable bottom is being formed at the 200-day MA, though the major indices have a lot of supply to absorb if this is to be the case. Since we don't know how long the retracement will last, the best plan of action is to wait for the market's momentum to stall on the upside, then look for breakdowns below the hourly uptrend lines. At that time, we will be initiating new short positions in ETFs that have shown the most relative weakness. Until the upside momentum runs out of gas, the two possible choices are to sit in cash or look for short-term buys in ETFs that have low-risk chart patterns.

Looking for potential short-term long entries over the next several days, we scanned the charts of several hundred ETFs. One of the best plays we found was in the Semiconductor HOLDR (SMH). Take a look at the daily chart:



Like the broad market, SMH has steadily corrected from its highs over the past several weeks. However, unlike many of the major stock market indexes, its chart pattern has not broken down. Yesterday, it dipped well below its 50-day MA, but formed a bullish "hammer" candlestick pattern into the close. More importantly, it also closed right on support of its daily uptrend line that began with the low of April (the dashed ascending red line). If SMH rallies above yesterday's high, it will also have moved back above its 50-day MA. Upon doing so, momentum could carry SMH higher for at least a one to three days (don't bet on more right now). If we drill down to the shorter-term hourly chart, you will also see that a rally above yesterday's high also coincides with a breakout above the hourly downtrend line from the July 17 high. This would further give SMH a boost:



Until the market proves otherwise, the short side of the market carries a much better chance of profitability in the intermediate-term. But that doesn't mean we can't buy the short-term bounces along the way. If you choose this option over waiting in cash, here are four tips for counter-trend trading in the short-term. First, be sure to reduce your position size in order to decrease your risk. Second, consider selling into strength to lock in profits, rather than trailing a stop to maximize your gains. Third, you must be disciplined to follow your pre-determined stop price because upside reversals can easily fail in this type of environment. Fourth, don't forget the primary trend is down right now. Don't be too stubborn to switch to the other side of the market if/when it begins to run out of gas again.

Open ETF positions:

Long - (none)
Short - EEM

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.