A strong opening in the stock market quickly faded last Friday morning, causing the major indices to finish near the flat line and with mixed results. After briefly probing to a new high of the year on the opening bell, the Nasdaq Composite immediately reversed and trended lower throughout the first half of the day. A feeble afternoon rebound attempt lifted the index out of negative territory, but the Nasdaq closed only 0.1% higher. The S&P 500 and Dow Jones Industrial Average followed similar intraday patterns before finishing lower by 0.2% and 0.4% respectively. Small caps showed relative weakness, causing the Russell 2000 to slip 0.7%. The S&P Midcap 400 edged 0.2% higher. The main stock market indexes closed near the bottom third of their intraday ranges, and with modest gains for the week.

Total volume in the NYSE increased 2%, while volume in the Nasdaq rose 9% above the previous day's level. Although the loss in the S&P 500 was too small to technically declare a "distribution day," bearish "churning" was abound. When an index trading near the highs of its range closes nearly unchanged, on higher volume, stealth institutional selling into strength, known as "churning," is usually the culprit. Given the market's inability to hold substantial opening gains, this was even more apparent in last Friday's action. Turnover in the Nasdaq exceeded its 50-day average level for the first time in a week, but it certainly wasn't the type of price action the bulls wanted to see.

Last Friday, we made two trades in the model ETF portfolio. The first was a buy entry into the Oil Service HOLDR (OIH), which we illustrated as a potential buy setup in our most recent commentary. The opening strength of the broad market caused OIH to gap above its highs of the previous two days, thereby triggering our buy entry for a HALF position. However, because of the stock market's immediate, bearish reversal, the early strength in OIH quickly faded, causing it to slide back into its previous range. As such, we made a judgment call to sell OIH for a very small loss, rather than holding a trade with a trigger price that failed to confirm itself.

On the positive side, precious metals surged higher in last Friday's session, prompting us to add to our position in Gold Double Long (DGP). In the August 25 issue of The Wagner Daily, we pointed out the bullish "pennant" formation on the weekly chart of SPDR Gold Trust (GLD), the regular, non-leveraged version of DGP. After rising 0.7% last Friday, GLD is now only pennies away from testing upper channel resistance of the "pennant" we recently illustrated. As momentum is picking up and GLD closed at its highest level in weeks, we added another 25% to our existing position in DGP last Friday. The daily chart of GLD is shown below:



In last Friday's commentary, we discussed the relative weakness iShares China Xinhua 25 (FXI) has recently been exhibiting. Because Chinese ADRs comprised many of the leading stocks that led the U.S. markets higher in recent months, we said that a sudden, bearish reversal in the Chinese market could be a "reliable warning signal that a correction in the U.S. broad market is forthcoming." Specifically, we were focused on whether or not FXI would follow through on the bullish "hammer" candlestick it formed on August 27 -- it didn't. Rather, it closed near the previous day's low, and right on its 50-day moving average. If FXI slices through its 50-day MA, and convincingly closes below it in today's session, we feel it could have the implication of a subsequent correction in the domestic markets. Below is an updated daily chart of FXI:



Overnight, the Shanghai Composite tumbled 6.7%, triggering losses on other Asian exchanges, and undoubtedly putting pressure on the U.S. stock market futures in today's pre-market session. Obviously, there's now a very good chance FXI will fall through its 50-day MA today. Based on current indications of the U.S. futures, which are pointing to a substantially lower open for the stock market, we can't help but believe overnight weakness in China was a significant, contributing factor.

Overall, last week's session was marked by choppiness and indecision. On August 21, the major indices broke out to new highs of 2009, but they have failed to make significant headway since then. Instead, it's been a tug-of-war between the bulls and bears, as evidenced by the price action of the past two trading days. With the major indices now exhibiting the real possibility of failing their recent breakouts, be prepared for high volatility in the coming days. It's probably a good time to sit on the sidelines, focusing on managing existing positions, rather than entering new ones. If the broad market makes a clear move out of last week's trading range, in either direction, it will provide us with more direction that will increase our odds of staying on the right side of the market.

Open ETF positions:

Long - DGP, VXX, IBB
Short - FXI, TWM long (an inversely correlated ETF)

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.