The broad market snapped its four-day winning streak yesterday, but the lighter volume pullback was relatively moderate. The major indices got off to a lower start, then drifted south throughout most of the day, but a wave of buying in the final thirty minutes enabled stocks to recoup a majority of the day's losses. The Nasdaq Composite receded 0.6%, the Dow Jones Industrial Average 0.8%, and the S&P 500 1.4%. The small-cap Russell 2000 slipped 0.8%, as the S&P Midcap 400 fell 1.7%. Continuing relative strength in the Nasdaq enabled the tech-heavy index to close near its best level of the day. Both the S&P and Dow, however, settled near the middle of their intraday ranges.

Turnover eased across the board, enabling the S&P and Nasdaq to steer clear of a "distribution day." Total volume in the NYSE was 6% lighter than the previous day's level, while volume in the Nasdaq ticked 4% lower. After four consecutive days of gains, a broad-based price correction was not surprising. But what mattered more is whether or not stocks retraced on lower or higher volume. The lower volume in both exchanges tells us yesterday's losses were more the result of the bulls taking a rest, as opposed to the bears aggressively stepping in to sell.

On May 29, we bought the Oil Service HOLDR (OIH) when it broke out above resistance of its prior "swing high," as well as a multi-week base of consolidation. Initially acting well, OIH climbed nearly 5% the day after entry, then quietly consolidated throughout the following session. Yet, despite the bullish short-term price action, OIH, along with other energy ETFs, got slammed yesterday. Take a look:



Our initial stop in OIH on the breakout entry was $97.89, just below convergence of the 20 and 200-day moving averages at the time. However, because the price action of the breakout lacked momentum, we immediately raised our stop to $104.70, just below the breakout level of the May 7 high. It's fortunate we did, as that enabled us to minimize our loss yesterday. Even though the broad market's late-day bounce enabled OIH to move back above the breakout level and our stop price, the one-day correction was still too steep. Consider tight stops on other energy ETFs you may be positioned in, as yesterday's price action in the sector was rather negative.

We're becoming intrigued by the daily chart pattern developing in the Bank Index ($BKX). From the March 2009 low through the May 2009 high, the $BKX showed a lot of volatility during its ascent off the lows. But over the past two weeks, the index has settled into an extreme volatility contraction. We've taken an ETF position in the sector twice during this time, once on the long side, once on the short side, when the sector appeared to be breaking out of its volatility contraction. Both times, however, we quickly scratched the trade (closed near breakeven) due to lack of follow-through. On daily chart of the $BKX below, notice how extremely tight the trading range has become:



The longer a stock, ETF, or index is stuck in a volatility contraction, the more powerful the eventual "breakaway" move will be, regardless of which direction momentum takes it. Therefore, we should expect to see a pretty significant move in the near future. If watching the banking sector, waiting for an ETF play on the volatility expansion, look for the first instance where there appears to be high momentum and volume in individual stocks such as JP Morgan (JPM), Bank of America (BAC), and Wells Fargo (WFC). This will likely be the "breakaway" day, and should provide us with a short-term trade opportunity in whichever direction the breakout goes. This move will also have a large impact on the trend of the S&P 500 that day.

As explained yesterday, we're now in "pullback buying" mode, waiting for the strongest ETFs to come into short-term support levels. We've now had the first day of a correction, so the direction of the market in today's session will help us determine whether to expect deeper retracements in leading ETFs, or to start selectively re-entering the market sooner. Also, don't forget about pivotal resistance of the 200-day MA for the Dow. Like we said yesterday, "...public perceptions have a significant role in moving markets. As such, we feel it's important for the Dow to join the rest of the gang; otherwise, it's a very real possibility the Dow will keep further gains of the rest of the broad market in check."

Open ETF positions:

Long - FXY
Short - (none)

Deron Wagner is the Founder and Head Trader of both Morpheus Capital LP, a U.S. hedge fund, and MorpheusTrading.com, a trader education firm.