Following through on the previous day's pullback, the main stock market indexes registered another session of losses last Friday. Like the previous session, stocks showed a bit of strength on the open, but drifted lower as the day progressed, picking up downside momentum just after mid-day. The Dow Jones Industrial Average lost 1.7%, the Nasdaq Composite 1.8%, and the S&P 500 2.0%. The small-cap Russell 2000 and S&P Midcap 400 indices fell 3.2% and 2.9% respectively. Small and mid-cap stocks often lead the broad market in both directions, as they did last week. Each of the major indices finished just above its intraday low. Regardless of the weakness, the major indices still logged decent gains for the week. The Nasdaq advanced 1.8%, the S&P 500 1.6%, and the Dow 0.8%.

Higher turnover across the board technically caused both the S&P 500 and Nasdaq Composite to register a bearish "distribution day" for the second time in a week. Total volume in the NYSE jumped 25%, while volume in the Nasdaq ticked 7% higher. Still, despite the appearance of institutional selling, much of the increased pace of trading was likely attributed to last Friday's "quadruple witching" options expiration. When stock options, stock index futures, stock index options, and single stock futures simultaneously expire, once per quarter, it typically leads to a volume spike in the stock market.

Internet HOLDR (HHH) is one ETF we're keeping an eye on this week. Showing relative strength to the major indices, HHH merely traded in a sideways holding pattern while the major indices fell apart in recent months. Over the past several weeks, HHH has been consolidating above support of both its 20 and 50-day moving averages. If it sees any strength this week, it will break out above a key area of horizontal price resistance, which should cause it to surge higher in the short to intermediate-term. The longer-term weekly chart of HHH is shown below:



As per the horizontal line on the chart above, the buy trigger for a momentum trade in HHH is over the $35 area. If trading a breakout in HHH, there are a couple things to be aware of. First, realize it's not a very well diversified ETF. Amazon (AMZN) and e-Bay (EBAY) comprise approximately 50% of its underlying stock portfolio. Google (GOOG) is not included in the portfolio, as HHH was created before Google's stock even existed. Because AMZN has a bullish daily chart (we're presently long in the MTG Stalk Sheet, and EBAY is poised to break out above its 50-day MA, we like HHH for a short to intermediate-term trade on the breakout. However, just be aware it's not a very well diversified ETF. Finally, realize that all the HOLDRS can only be traded in increments of 100 shares (no odd lots).

Based on the losses of the past two days, the stock market has apparently entered into the "pullback mode" we've been discussing in recent days. However, as of four hours before today's open (Monday), the S&P and Nasdaq cash futures markets are pointing to upside opening gaps of 2% to 3%. This means the major indices are on pace to open at or above last Friday's highs. If the opening gap holds throughout the day, and stocks close above last Friday's highs, it will be a very bullish sign that the market just isn't ready and willing to rest for more than a day or two.

In last Friday's commentary, we used Fibonacci retracements to look at how steep a pullback stocks could experience if they pulled back further. If today's pre-market gap holds up, and the major indices close above last Friday's highs, stocks will have only done a 23.6% Fibonacci retracement, reversing higher before even touching their 38.2% retracement levels. Since the strength of a trend can be determined by how steep the pullbacks are, a retracement to just the 23.6% level minimal is highly indicative of a strong upward underlying trend. The only thing stronger would be a complete correction by time (price consolidation), rather than pulling back at all. Curiously, the apparent strength of the developing uptrend is just as bullish as the preceding downtrend was bearish. Recall that bounces within the course of the downtrend were quite minimal.

If/when the major indices move above last week's highs, they will have reversed their intermediate-term downtrends by breaking out above their multi-month downtrend lines. Such a breakout would also enable each index to move back above its 50-day moving average, a closely-watched indicator of intermediate-term trend direction. To illustrate this, check out the daily charts of the S&P 500, Nasdaq Composite, and Dow Jones Industrial Average:







Presently, we have four long positions, only one of which is directly correlated to the direction of the overall stock market (QLD). However, if the main stock market indexes break their intermediate-term downtrend lines by rallying above last week's highs, we'll be much more comfortable playing the long side of the market for more than just a quick counter-trend bounce. As for shorts, the market's recent price action has given us no reason to look for new short selling opportunities at the present time. Rather than trying to predict when/if the market heads back down, we'll let price and volume guide our actions, trading what we see, not what we think.

Open ETF positions:

Long - QLD, SLV, USO, UGA
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.