Breaking their three-day winning streak, stocks followed up the previous day's strong gains with a modest pullback on lighter volume. The major indices traded in positive territory throughout the morning, drifted lower at mid-day, then recovered off their lows in the afternoon. The end result was small losses across the board, with closing prices matching the slightly lower opening prices. The Dow Jones Industrial Average edged 0.1% lower, while both the S&P 500 and Nasdaq Composite slipped 0.3%. The small-cap Russell 2000 and S&P Midcap 400 indices were lower by 0.3% and 0.6% respectively. All the main stock market indexes closed around the bottom third of their relatively narrow intraday ranges.

Total volume in the NYSE decreased 4%, while volume in the Nasdaq was 1% lighter than the previous day's level. Turnover in both exchanges remained well above average levels. Market internals were only marginally negative. In both the NYSE and Nasdaq, declining volume exceeded advancing volume by a ratio of less than 2 to 1. Overall, the modest price changes of the major indices, as well as nearly flat market internals, means yesterday was primarily a great big day of nothing.

In yesterday's newsletter, we took an updated look at the weekly charts of the S&P 500 and Nasdaq. Specifically, we illustrated how far both indices have retraced off their March lows, in relation to the depth of their multi-year declines. While most of our actionable trades are based on the daily and weekly chart intervals, we regularly monitor the even longer-term monthly time intervals. While the timeframe is too long to base specific short to intermediate-term trading decisions on it, notable observations are occasionally made that help keep overall market trends in perspective. This is because such a long time frame eliminates much of the "noise" apparent on daily and, to a much lesser extent, weekly charts. Right now is one of those periods when the monthly chart of the S&P 500 is worth pointing out:



Since at least the middle of 2003, notice how perfectly the 20-month simple moving average of the S&P 500 has perfectly acted as a long-term trend indicator. Circled in pink, notice how each touch of this moving average led to a resumption of the dominant trend. From 2003 through 2007, the dominant trend was obviously "up." Then, in January of 2008, the S&P 500 finally cracked support of its 20-month MA for the first time in nearly five years. At that moment, the 20-month MA became the new resistance level. This is because the basic rule of technical analysis dictates a prior level of support will become the new resistance level, after the support is broken. This was proven to be true in May of 2008, when the index rallied into new resistance of that 20-month MA, only to swiftly move lower after bumping into it. Now, for the first time since then, the benchmark S&P 500 is again testing that pivotal, long-term resistance level.

Even though the 20-month moving average has perfectly acted as support, then resistance, for the past six years, this does NOT mean you should immediately dump all your long positions and start selling short. The first thing to consider is an index will frequently exceed a closely-watched level of support or resistance by as much as two to three percent before the support/resistance level has any effect. This is known as an "undercut," and frequently provides traders with a very low-risk area to enter new positions in the direction of the dominant trend. In this case, that would be a long-term downtrend, but the same concept applies when an uptrending ETF or stock "undercuts" support of its 50-day moving average. Quite often, the brief violation of the 50-day MA provides an ideal buy entry for traders anticipating a resumption of the dominant uptrend. Our recent buy entry into PowerShares Base Metals (DBB) was a good example of this; we bought DBB after it "undercut" support of its 20-day exponential moving average (EMA). The next day, DBB gapped back above its 20-day EMA, and is now poised to break out above the high of its recent range.

In addition to realizing the S&P 500 could easily probe above its 20-month moving average by several percent before pulling back, one must also remember that each bar on the chart above represents an entire month of trading. As such, the S&P could easily hang out around its 20-month MA for several months before resuming its long-term downtrend, or perhaps reversing it. In 2003, 2005, and 2006, the S&P 500 touched its 20-month MA for two consecutive months before moving higher. Therefore, because the time frame of this chart is so long, actionable trading decisions should not be based on it. Nevertheless, some traders may consider resistance of the 20-month moving average to be a good reason to at least lighten up on long-term stock investments, into strength of the market's current rally. As always, this is not meant to be advice, but merely a presentation of the technical facts before us. Overall, this 20-month moving average merely tells us the broad market is coming into a key inflection point, in which stocks will either "make it or break it."

Open ETF positions:

Long - DGP, DBB (sold IBB position into strength yesterday, locking in a solid gain)
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.