After gapping higher on the open, the broad market oscillated in a tight, sideways range before closing with solid gains. Unlike the previous two sessions, strength in the final thirty minutes of trading enabled all of the major indices to climb at least one percent and close near their intraday highs. The Nasdaq Composite led the way again, rallying 1.3%, the S&P 500 gained 1.2%, and the Dow Jones Industrial Average advanced 1.1%. The small-cap Russell 2000 and S&P Midcap 400 indices were higher by 1.3% and 1.4% respectively.

Not only was the intraday price action an improvement over recent sessions, but volume also picked up a bit. Total volume in the NYSE increased 7% over the previous day's level, while volume in the Nasdaq rose 8%. Though turnover ticked only moderately higher, it was enough for both the S&P and Nasdaq to score a bullish "accumulation day." Strong market internals also confirmed the higher volume gains. Advancing volume in the NYSE exceeded declining volume by 5 to 1. The Nasdaq ratio was positive by 3 to 1.

Despite yesterday's decent session, both the S&P 500 and Nasdaq Composite closed right at key resistance of their intermediate-term downtrend lines. The "moment of truth" is coming soon, as the ability or inability to climb above their month-long downtrend lines will clearly show us whether or not institutional buying has returned. Take a look at the proximity of the downtrend lines to yesterday's closing prices:





At the very least, one should expect an intraday probe above these downtrend lines today. At key support and resistance levels, the specialists typically run stops that investors place at obvious levels. However, it's the actual closing price that matters. Although not shown on the charts above, both the S&P and Nasdaq also closed at resistance of the 50% Fibonacci retracement from their July highs to August lows. In strongly trending markets (up or down), the 50% retracement level is usually difficult to overcome, at least on the initial attempt.

The major indices have now retraced substantially off their recent lows, but most of the gains from their August 16 lows have come in the form of opening gap ups, rather than intraday uptrends. This has made it difficult for traders to enter even near-term long positions with a positive risk/reward ratio. We have not been opposed to buying a few ETFs for quick, momentum-driven moves since the recent bottom, but price and volume action have not been very convincing. Conversely, it has been risky to put on new short positions since the August 16 reversal day because the broad market has not yet given us any signals that the bounce is finished. A break below the prior day's lows could trigger such a sell signal.

Because of the action described above, we have remained "flat and happy" over the past week. Considering the substantial gains we netted during the preceding selloff, there's been no reason to risk giving those profits back by taking unclear trade setups. Nevertheless, we bought a HALF position of the inversely correlated UltraShort Dow 30 ProShares (DXD) into yesterday's gap up in the Dow, just to dip a toe in the water. If you've been looking for a level to enter new short positions, the current test of the intermediate-term downtrend lines in the S&P and Nasdaq provides a very positive risk/reward ratio. This also means that new long positions at current levels provide a minimal risk/reward ratio because of the key resistance just overhead. If the indices blow through their downtrend lines on a CLOSING BASIS today, all bets on the short side would be off. Otherwise, one could assume the established downtrend lines will remain intact, leading to subsequent selling pressure in the broad market.

Open ETF positions:

Long - DXD (half position)
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.