Building on the previous day's momentum, stocks got off to a strong start yesterday morning, but an afternoon reversal caused most of the major indices to finish slightly lower. After rising nearly 1% at their intraday highs, both the S&P 500 and Nasdaq Composite finished 0.1% lower. The Dow Jones Industrial Average was unchanged. The small-cap Russell 2000 slipped 0.2%, as the S&P Midcap 400 lost 0.4%. All the main stock market indexes finished in the bottom quarter of their intraday ranges.

Turnover receded from the previous day's levels, which were inflated due to the monthly expiration of options contracts. Total volume in the NYSE decreased 17%, while volume in the Nasdaq was 12% lighter than the previous day's level. Like the percentage changes of the major indices, market internals were nearly flat. In the NYSE, advancing volume fractionally exceeded declining volume. The Nasdaq adv/dec volume ratio was slightly negative.

One of the dominant reasons for the stock market's afternoon reversal yesterday was the sudden decline in the performance of financial stocks. When the major indices bounced off support of their 20-day EMAs last week, the financial sector was one of the driving factors behind the strength that led the main stock market indexes to close at fresh 2009 highs. However, many financial ETFs sold off substantially yesterday, causing them to form potential "double top" patterns on their charts. The Regional Bank HOLDR (RKH) turned an early 1.7% gain into a closing loss of 1.8%, representing a sharp intraday reversal of approximately 3.5%. The possible "double top" is shown on the hourly chart of RKH below:



The KBW Bank SPDR (KBE), which showed relative strength to RKH throughout last week, surged well above its prior high in the morning session. However, it reversed to close just below its breakout level from the previous high of early August. The popular S&P Financial SPDR (XLF) formed a similar pattern as well. The hourly charts of both ETFs are shown below:





Since financials were one of the sectors that led the stock market higher last week, the performance of the industry could be a leading indicator of the direction of the overall market this week as well. As for an actionable trade setup, only advanced, aggressive traders looking for a quick, momentum-driven opportunity should consider short selling the financial ETFs here (with a tight stop over yesterday's high). Short selling the financials at current levels is not ideally suited for trend traders who focus on buying pullbacks and breakouts in the dominant direction of a trend, which is the primary strategy of this newsletter.

The SPDR Gold Trust (GLD), which mirrors the price of the spot gold commodity, has been rather choppy in recent weeks, but continues to oscillate within the confines of a "pennant" formation on its weekly chart. With the upper and lower channels of the pennant closing in on the current price of GLD, one should soon expect a strong breakout in either direction. Since a pennant is generally a continuation pattern of the dominant trend, odds would eventually favor an upside breakout in GLD. We're already positioned in Gold Double Long (DGP), which has a similar chart pattern. The long-term weekly chart of GLD is shown below:



Although the major indices broke out to new highs of the year last Friday, closing prices below yesterday lows would cause the main stock market indexes to slide back below their prior highs and breakout levels. In our August 21 commentary, we said, "Still, even if the broad market manages to rally back to test its prior highs, we would now be on alert for failed breakouts." Based on yesterday's bearish reversal in the financials, that chance of failed breakouts in the major indices now looks like a realistic possibility. Unfortunately, such action could put the broad market back into the same quagmire of indecision that recently plagued the stock market for weeks.

Open ETF positions:

Long - IBB, DGP, DBO
Short - FXI

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.