The market got off to a scary start yesterday morning, but key support of the prior lows from March enabled stocks to reverse their losses into the close. After trending lower throughout the first half of the session, the major indices bottomed just after mid-day. A choppy rally ensued that enabled stocks to erase their losses. Both the S&P 500 and Dow Jones Industrial Average were down 2.7% at their intraday lows, but the S&P actually finished 0.3% higher and the Dow trimmed its loss to just 0.1%. Although the Nasdaq Composite lost 0.3%, the small-cap Russell 2000 showed major relative strength by advancing 2.3%. The S&P Midcap 400 Index edged 0.1% higher. Most of the major stock market indexes settled about ten percent below their intraday highs.

Massive volume accompanied yesterday's volatility, in proportion with the historic levels set earlier in the month. Total volume in the NYSE surged a whopping 50%, while volume in the Nasdaq similarly increased 45% over the previous day's level. Yesterday's NYSE volume of 2.99 billion shares set a new record, exceeding the previous all-time high that was recorded on August 9 of this year. Turnover in the Nasdaq fell just shy of its historical high that was also set earlier this month. With several down days in recent weeks coinciding with record or near-record volume levels, it's quite apparent that institutions have been making a mad dash for the exit doors. Nevertheless, yesterday's volume surge accompanied a bullish intraday reversal. When this type of action occurs after a steep, protracted downward move, it often signals the formation of at least a short-term bottom.

Investors who don't pay attention to technical support and resistance levels in the broad market might have been panicking when the S&P 500 was down nearly 3% yesterday. However, we've been telling subscribers that key support of the prior lows from March would probably stop the pain, at least temporarily. Based on this knowledge, one might have rested a bit easier, as the prior lows from March is where the S&P reversed yesterday afternoon. On a daily closing basis, 1,373 marked the March low. Yesterday, the S&P 500 dipped just three points below that level, running stops in the process, then began its sharp reversal. The bounce off the area of prior lows from March is illustrated on the weekly chart below:



Neither the Nasdaq nor Dow touched their prior lows from March, as both indexes have been showing relative strength to the benchmark S&P since the correction began. Though it dipped several hundred points below it on an intraday basis, the Dow still managed to close a few points above its 200-day MA. This prevented the last of the benchmark indexes from breaking its 200-day MA:



Yesterday's steep intraday losses that preceded the late afternoon rally caused all of the major indices to form bullish "hammer" candlestick patterns on their daily charts. When this pattern forms after an extended downward move in a stock or index, it often indicates a short-term bottom is shaping up. Yesterday's volume surge that accompanied this pattern is also bullish, as it points to possible capitulation. Still, we honestly cannot recommend buying any stocks or ETFs until the market proves that yesterday's reversal wasn't just a fluke to suck in the bulls. With downward momentum so strong, it remains quite risky to be on the long side of the market. As for shorts, you probably want to stay clear of those as well, at least until we see how far the market retraces before running out of gas again.

As per the plan we outlined in yesterday morning's commentary, we are now flat and happy. Into the opening gap down, we covered our short position in the Oil Service HOLDR (OIH) for a gain of 7.3 points on just a two-day hold. We also sold the remaining shares of the Short Russell 2000 ProShares (RWM) for a profit of nearly 5 points. We've been fortunate enough to have a rather profitable month amidst the carnage, so there's no rush for us to jump back in the market at the first sign of a bounce. Instead, we plan to patiently analyze from the sidelines, then wait for substantial bounces before selectively entering new short positions.

Open ETF positions:

Long - (none)
Short - (none)

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.