The start of a new month granted no reprieve to ailing stocks, as the major indices nosedived to build on their recent wave of losses. The broad market gapped lower on the open, then settled into a steady downtrend that persisted throughout the entire session. The Nasdaq Composite plunged 4.0%, the Dow Jones Industrial Average 4.2%, and the S&P 500 4.7%. Small and mid-caps suffered even more pain; the Russell 2000 skidded 5.5% and the S&P Midcap 400 declined 6.1%. Each of the main stock market indexes closed at or near its intraday low.

Turnover receded from the previous day's levels, but trading still remained well above 50-day average levels. Total volume in the NYSE declined 12%, while volume in the Nasdaq pulled back 7%. Volume has been above average levels in each of the past fourteen days. Since nearly every one of those sessions was a "down" day, institutions have not yet shown signs of easing their selling operations.

In yesterday morning's newsletter, we pointed out the potential breakouts in a couple inversely correlated "Short ETFs." Given the massive losses in the broad market, it's not surprising that both tickers (EEV and SRS) subsequently went on to score decent gains. Nevertheless, because both ETFs began the day sharply higher, we did not see an "official" intraday entry point in the UltraShort ETFs we really were thrilled about. If a realistic price target is not at least twice as much as the initial risk (points to the stop), we will often pass on a trade due to a low reward/risk ratio. Most importantly, even though we did not enter any of the Short ETFs, we stayed out of harm's way, on what turned out to be a very bad day for the market. Capital preservation in a nasty bear market should always be your top priority, well before worrying about profiting on the short side. In that regard, we have been content with the simple fact that our model ETF account hasn't dug a hole throughout this overly bearish environment.

Going into today, we're monitoring iShares Silver Trust (SLV) for potential buy entry. We already have a position in spot gold (DGP), and we're now looking to add silver to our portfolio as well. The correction of the past week has caused SLV to set up for an ideal buy entry above yesterday's high. Take a look:



SLV recently undercut its 20-day and 200-day moving averages, which have converged at the $13 area. However, the pullback within the uptrend of SLV may soon be finished because the trading range of SLV is tightening up. For this setup, we simply like a buy entry above yesterday's high. A rally above yesterday's high will help to confirm the reversal of momentum, and will also cause SLV to move back above its 20/200-day MA convergence. As always, it's important to not "jump the gun" with a premature entry. Specifically, we're waiting for a rally above the $13.10 area to get long. We also still continue to watch DGP for the point at which we'll add the additional shares of our partial position.

The bad news about the overall state of the stock market right now is that the S&P and Dow are trading at nearly 12-year lows. As such, there is a complete lack of prior price support levels to help reverse the deluge of selling. This makes it impossible to know when stocks will eventually find a meaningful bottom. But just as bull markets cannot go straight up forever, nor do bear markets. The good news, therefore, is that stocks will eventually put in a bottom -- perhaps not the absolute bottom of the long-term downtrend, but at least a sustainable rally. Until that happens, your number one priority must be preservation of capital, so that you'll be able to fully capitalize on the wonderful buying opportunities that will eventually fall in our laps.

The big question on everyone's minds, of course, is when will the market actually form that elusive, much sought-after bottom? Obviously, nobody knows. Still, there's one major technical indicator that has a historically high level of accuracy for preceding significant market bottoms. It is known as "capitulation."

Capitulation usually occurs when the most ardent of "buy and hold" investors finally give up hope and sell their shares at any cost, throwing their hands up in utter frustration. At that point, institutions such as hedge funds and mutual funds step in to scoop up those cheap shares, attracting the interest of other speculators, as well as forcing short sellers to cover their positions. Typically, this process of capitulation is marked by at least one day of monstrous volume that far exceeds the levels of preceding sessions. The accompanying intraday price action is sometimes, but not always, marked by steep losses at some point during the day, followed by strength into the close.

So far, we have not yet seen these signs of capitulation. Nevertheless, it's beneficial to know what we're looking for beforehand. But even if the market flashes these signals of capitulation, realize it does not give us the "all clear" symbol to start buying like a madman. Rather, it tells us to back off with any short positions, and to be on the lookout for developing strength in specific industry sectors and leading stocks. Rest assured, we'll be here to report it when the market eventually exhibits the typical behavior of capitulation. Until then, just protect that capital so you'll be around to smile when better times return.

Open ETF positions:

Long - DGP
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.