Finishing the week on a high note and with their fourth straight day of gains, stocks gapped higher on the open, surged higher in the morning, then traded in a tight, sideways range throughout the remainder of the day. The S&P 500 ramped up 1.9%, the Dow Jones Industrial Average 1.7%, and the Nasdaq Composite 1.6%. The small-cap Russell 2000 and S&P Midcap 400 indices closed higher by 2.3% and 1.9% respectively. All the major indices finished at their best levels of the day, and even at new highs of the year.

Turnover surged higher across the board, though much of the volume spike was likely attributed to the monthly expiration of options contracts. Total volume in the NYSE came in 41% greater than the previous day's level, while volume in the Nasdaq increased 15%. Turnover in both exchanges also moved back above 50-day average levels. Market internals were also quite strong in last Friday's "accumulation day." In the NYSE, advancing volume trounced declining volume by a margin of 14 to 1. The Nasdaq adv/dec volume ratio was positive by nearly 5 to 1.

The purpose of technical analysis is to slightly tip the odds of profitable trading in one's favor by following a set of historical patterns that tend to repeat themselves over and over. It works simply because the patterns and trends of technical analysis are formed by human psychology, namely the emotions of fear and greed, which really doesn't change over the years. But while technical analysis is designed to increase one's odds of profiting in the stock market, it's imperative to understand there are obviously never any guarantees stocks and ETFs will follow-through in the direction technical analysis predicts (hence the purpose of stop losses). Last week's action was a good reminder of such.

On August 17, we said the major indices would likely "undercut" support of their 20-day exponential moving averages (EMAs), and then bounce to retrace some of the previous week's losses. However, given the breakdown below the lengthy bases of consolidation, the numerous "distribution days" of the S&P and Nasdaq, and the laggard performance of leading individual stocks, we suggested stocks would likely bounce off their 20-day EMAs to recover half to two-thirds of their losses, then head back down to make another leg lower in the near-term. While technical analysis enabled us to very accurately predict the "undercut" and bounce off the 20-day EMAs in the days that followed, the fact that the main stock market indexes zoomed to near highs of the year means we were just plain wrong (or perhaps early) in our analysis that the bounce would quickly fizzle out.

Regardless of being wrong, the action taken by our objective assessment led to only minimal loss of capital; we merely closed our position in UltraShort Russell 2000 (TWM) for an approximately average loss of capital. Our short position in iShares China Xinhua 25 (FXI) has showed relative weakness by moving only a few cents against us since our entry. Meanwhile, all but one of our long positions moved back up alongside of the broad market. By slowly taking action when spotting a potential change in market sentiment, we positioned ourselves for substantial profit if our technical assessment proved to be correct, but also moderated our downside risk if we were wrong (which we were). If you look at our historical performance results over the years, you'll see there have been many periods where being wrong caused us to sustain losses, but a firm adherence to consistently following our plan is the reason we have consistently outperformed the broad market by a wide margin, over the long-term. Despite last Friday's loss in TWM, for example, our model ETF portfolio is still showing a net gain of 4.7% over the past two months. We simply don't worry about losing trades along the way because they're a necessary part of the business of trading.

Most industry sectors moved higher alongside of the stock market's run last week, but only a handful actually showed relative strength to the broad market by breaking out to new highs of the year as well. Rather, sectors such as Semiconductors ($SOX), Biotechnology ($BTK), Transportation ($DJT), and Retail ($RLX) remain below resistance of their July 2009 highs. Conversely, Banking ($BKX), Oil ($XOI), and even Utilities ($DJU) were among the leading industries last week. This week, one industry sector ETF we're stalking for potential buy entry is Oil Service HOLDR (OIH): 



Since mid-June, OIH has been forming a bullish "cup and handle" pattern on its daily chart. Over the past five weeks, OIH has been forming a tight, sideways base, right at support of its 20 and 50-day moving averages. On Friday, OIH rallied to finish the week slightly above its July 2009 high. Within the coming days, we're watching for a high-momentum breakout in OIH, which could be driven by the five-week base with "cup and handle" breakout. We're already positioned in PowerShares Oil Fund (DBO), which roughly tracks the price of the crude oil commodity, but the crude futures and oil service sector don't necessary trade closely in sync with one another (the same is true of spot gold futures and individual gold mining stocks).

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.