Following through on the previous afternoon's late-day slide, the major indices suffered a second consecutive day of substantial losses across the board. Stocks opened slightly higher, but the bears quickly took control, setting in motion a downtrend that persisted throughout the morning session. Thereafter, the main stock market indexes consolidated near their intraday lows, through the remainder of the day. Although the blue-chip Dow Jones Industrial Average fell only 0.4%, the tech-heavy Nasdaq Composite shed 1.1%. The benchmark S&P 500 lost 1.0%. Small and mid-cap stocks showed significant relative weakness. The Russell 2000 and S&P Midcap 400 indices tumbled 1.9% and 1.7% respectively. It was the broad market's worst day of average losses since September 1. All the major indices finished around the bottom quarter of their intraday ranges.

Total volume in the NYSE increased 4%, causing the S&P 500 to register a bearish "distribution day." Turnover in the Nasdaq, however, was 2% lighter than the previous day's level. In both exchanges, trading was above 50-day average levels. A healthy market can typically absorb a couple days of institutional selling, but the presence of four or more sessions of higher volume losses within a period of several weeks typically leads to a meaningful pullback in the market. Yesterday was the second straight "distribution day" for the S&P, but it's positive that volume in the Nasdaq was slightly lower. Market internals were ugly. In the NYSE, declining volume exceeded advancing volume by nearly 7 to 1. The Nasdaq adv/dec volume ratio was negative by 5 to 1.

In yesterday's commentary, we discussed the bearish patterns in several oil-related ETFs, as well as the divergent bullishness in the natural gas commodity ETF. Yesterday, that interesting trend continued. U.S. Oil Fund (USO), which broke support of a five-month uptrend line on Wednesday, fell 3.3% yesterday. Supply pressures from the latest inventory report has caused USO to plunge more than 8% within the past two days. The weakness in crude had a positive effect on the price of UltraShort Oil and Gas ProShares (DUG), an inversely-correlated "short ETF" we bought on September 23; DUG rose 4.0%.

Despite another day of weakness in most commodities (including precious metals), U.S. Natural Gas Fund (UNG) bucked the trend again. UNG gained 2.5% yesterday, and is now poised to gap above its 50-day moving average within the next few days. If it does, the breakout above its short-term consolidation will confirm the reversal of its intermediate-term trend. This is shown on the daily chart of UNG below:



When an ETF is showing so much relative strength that it continues to move higher while other ETFs in the sector are selling off, that ETF will usually be the first to rocket higher when the rest of the sector eventually bounces. Since UNG has managed to gain 5% over the past two days, even as PowerShares Commodity Index (DBC) has lost 3.5% during the same period, it should handily outperform on the first bounce in overall commodities. As we remain positioned in UNG from our September 23 entry, we're ready for the anticipated breakout above the 50-day MA and intermediate-term downtrend line.

One factor weighing on most commodities right now (except UNG, of course) is the sudden show of strength in the U.S. dollar. While not necessarily true 100% of the time, there is usually an inverse correlation between the value of the dollar and the price of commodities. The PowerShares U.S. Dollar Index (UUP), which represents the price of the dollar versus a basket of various foreign currencies, has been trending steadily higher ever since Wednesday afternoon's FOMC announcement on economic policy. Not surprisingly, that's when most commodities came under pressure. Below is the daily chart of UUP:



Even though UUP has been in a rather persistent downtrend, there are two bullish signals that hint at the formation of a short to intermediate-term bottom. First is the "undercut" that occurred on September 23. That day, UUP traded well below the low of its recent range on an intraday basis, but recovered to close above the low of its range, and even above the previous day's high. "Undercuts" are bullish because they have the effect of triggering stops and washing out the last of the bulls. With all the overhead supply eliminated, it becomes much easier for the stock or ETF to move higher thereafter. The second bullish signal is yesterday's volume spike that occurred on the rally above the high of the "undercut" day. Volume surging to more than three times its average daily level indicates institutional accumulation. While it's still too early to say UUP has reversed its dominant downtrend, a rally above its 20 and 50-day moving averages in the coming week could quickly change sentiment for the greenback.

As for the broad market, yesterday's losses caused the main stock market indexes to close just above support of their 20-day exponential moving averages (EMA). Since any further weakness in today's session could lead to a test of those 20-day EMAs, be careful with any momentum-based short positions you may have entered. Since the primary rally off the March 2009 lows began, the 20-day EMA has frequently provided perfect price support for the major indices. Most recently, the S&P 500's pullback to its 20-day EMA in mid-August, and again at the beginning of this month, both led to new highs of the year. Convincing breakdowns below the 20-day EMAs of the major indices could obviously lead to a more severe pullback in the broad market, but that hasn't happened yet. The only major technical reason to believe it may happen this time is long-term resistance of the 20-MONTH moving average of the S&P 500, which we recently illustrated in this newsletter. We'll take an updated look at the short to intermediate-term technical trends of the broad market early next week, in order to determine which new, actionable trade setups may be on tap.

Open ETF positions:

Long - UNG, DGP, GDX, DBB
Short - DUG (an inversely correlated "short ETF" we're long)

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.