After sliding more than 3% in the preceding two days, stocks recovered about one-third of those losses yesterday. The major indices opened in slightly positive territory, then grinded their way higher throughout the rest of the day. The Nasdaq Composite bounced 1.3%, the S&P 500 1.0%, and the Dow Jones Industrial Average 0.9%. The small-cap Russell 2000 and S&P Midcap 400 indices gained 1.5% and 1.3% respectively. The main stock market indexes closed in the upper 15% of their intraday highs.

While yesterday's rally was encouraging, one key element lacking from the action was higher volume. Turnover in the NYSE receded 17%, while volume in the Nasdaq came in 7% lighter than the previous day's level. Higher volume on the rebound day would have been an encouraging sign of buying among mutual funds, hedge funds, and other market-moving players. Instead, institutions showed little interest in participating in the rebound. Given the five days of higher volume selling in the S&P 500 in recent weeks, yesterday's lack of volume on the bounce was discouraging. However, in both exchanges, advancing volume exceeded declining volume by a margin of more than 5 to 1.

When several ETFs with relative strength began pulling back to short-term support levels last week, we entered positions in iShares Nasdaq Biotech (IBB) and Semiconductor HOLDR (SMH). If the market's uptrend remained healthy, this would have positioned us with new trade entries at ideal price levels. But because of the market's negative volume patterns, dismal performance of leading stocks, and the loss of short-term relative strength in the semiconductor sector, we made a judgment call to sell our position in SMH yesterday, netting a small loss of less than half a point. Although the possibility exists that SMH could recover back to its prior highs, there is now a plethora of overhead supply the ETF must contend with, including new resistance of its 20-day exponential moving average (EMA). This is shown on the daily chart of SMH below:



Although we sold SMH, we will continue to monitor the performance of the semiconductor sector in the coming weeks. If SMH pulls back to its 50-day MA and/or 10-week MA, we will consider a possible re-entry at a lower price. However, this will depend on the overall state of the broad market as well. As for IBB, we are still holding our position, but that's primarily because our initial risk exposure was based on only a half-sized position. The second half of the position never triggered for buy entry, so our risk on the current IBB position is already limited to half the normal capital risk of a trade.

Yesterday, both the S&P 500 and Dow Jones Industrial Average moved back above their 20-day EMAs. The Nasdaq still remains below its 20-day EMA. However, as shown on the weekly chart below, the Nasdaq is still within striking distance of breaking out above its long-term downtrend line:



Going into today, we continue to monitor the price action in leading individual stocks, as well as the overall broad market. Unfortunately for the bulls, yesterday's action resembled a typical, feeble rally attempt that follows two days of high volume selling. If stocks are to move back to their recent highs without correcting further, it would require a lot of volume to absorb the newly created overhead supply left in the wake of the selling. More likely, there's a decent possibility the major indices will now form short-term "bear flag" patterns on their daily charts, which could lead to another swift, downward move in the broad market. But with key support of the 50-day moving averages not far below the current prices of the major indices, short positions should only be attempted by traders who are comfortable with very short-term, momentum-based trades. If stocks break through their 50-day MAs, and then bounce into new resistance of those 50-MAs, new short setups with a potentially longer holding period may develop. For now, we continue to lay low with regard to new trade entries, analyzing both sides of the market for either new buy entries that pull back to support, or short-selling opportunities with relative weakness.

Open ETF positions:

Long - IBB, DBO, DGP, FXB
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.