Following through on the previous day's weakness, the major indices suffered another round of substantial losses last Friday. After opening slightly higher, stocks turned tail and trended lower throughout the morning. The broad market attempted to rebound at mid-day, but the bears resumed control later in the afternoon, causing the main stock market indexes to close just off their intraday lows. The Dow Jones Industrial Average fell 1.8%, the Nasdaq Composite 2.1%, and the S&P 500 2.3%. The small-cap Russell 2000 and S&P Midcap 400 indices shed 2.1% and 2.6% respectively.

The most damaging aspect of last Friday's session is that higher volume accompanied the losses. Total volume in the NYSE rose 4%, while Nasdaq volume increased 8% above the previous day's level. The losses on higher turnover caused both the S&P 500 and Nasdaq Composite to register a bearish "distribution day." Considering that the major indices attempted to break out just two days earlier, the presence of institutional selling so shortly thereafter is a rather negative sign.

On January 28, both the S&P 500 and Nasdaq Composite rallied more than 3%, and also managed to reclaim their 50-day moving averages. Unfortunately, however, neither index held above those pivotal levels for more than a few hours. Now, just two days later, both indexes have completely erased those gains and then some. Rubbing salt in the wound is the fact that Friday's heavier volume losses pointed to selling amongst mutual funds, hedge funds, and other institutions. Leading stocks have also turned in dismal performances over the past two days, another bearish sign for the overall market. Though the major indices have merely been oscillating in a sideways range for the past several months, that situation may be about to change. But unfortunately for the bulls, the eventual resolution out of that sideways channel may be to the downside.

Showing the most relative weakness of the main stock market indexes is the Dow Jones Industrial Average. Take a look at its daily chart below:



Unlike the S&P 500 and Nasdaq Composite, notice the Dow failed to even touch its 50-day MA last week. More notably, the Dow has already sold off down to the area of its January lows. If the Dow loses just 100 more points, closing below the 7,900 area, it will break support of its January lows (the blue dotted line). A breakdown below that level will likely trigger a wave of downward momentum that causes the Dow to quickly tumble to its November 2008 lows. If that six-year closing low of 7,552 is violated, the market's price action could get pretty ugly again. On the plus side, the S&P and Nasdaq are still several percent above support of their January lows, which could help prop up the Dow. Nevertheless, we now recommend a very cautious stance on any long positions correlated to the direction of the broad market.

Upon detecting last Friday's distribution, we decided it was time to dip our toes back into the short side of the stock market. We did so by purchasing the inversely correlated UltraShort Real Estate ProShares (SRS). On the daily chart, SRS has formed a "triple bottom," and broke out above its hourly downtrend line last Friday. Below are both the daily and hourly charts of SRS. On the hourly chart, you'll see the move above the downtrend line that triggered our buy entry at the $57.50 area (thanks to subscriber Tom for the initial heads-up on SRS):





In addition to our new SRS entry, we remain long DGP, GDX, and UGA. Even though our other ETFs are long positions, they have shown a low correlation to the direction of the stock market because they are commodity-related. DGP, in fact, surged to a fresh multi-month high while the stock market sold off last Friday. GDX is consolidating near its recent highs, just below its 200-day MA. UGA is in the process of breaking out above consolidation, with its 20 and 50-day MAs below, though the breakout has not yet been convincing.

Open ETF positions:

Long - DGP, GDX, UGA, SRS
Short - (none, but SRS is a "short ETF")

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.