Registering their third straight session of losses last Friday, stocks finally took a breather last week. The major indices began the day slightly lower, then trended south throughout the morning, but an afternoon recovery off the lows enabled the broad market to trim the day's losses. The Dow Jones Industrial Average lost 0.4%, the S&P 500 0.6%, and the Nasdaq Composite 0.8%. The small-cap Russell 2000 and S&P Midcap 400 indices fell 0.5% and 0.6% respectively. Like the previous day, the main stock market indexes closed above their worst levels of the session, but around the bottom quarter of their intraday ranges. For the week, the Dow Industrials shed 1.6%, the Nasdaq Composite 2.0%, and the S&P 500 2.2%.

One positive of last Friday's session was the losses were marked by substantially lighter volume. Total volume in the NYSE eased 13%, while turnover in the Nasdaq was 10% lighter than the previous day's level. The slower pace of trading prevented the S&P 500 from suffering what would have been its third consecutive "distribution day." As institutions backed off the sell button, volume in the NYSE receded below its 50-day average level. Turnover in the Nasdaq was still marginally greater than average. Going into this week, we'll be paying close attention to the market's price to volume relationship; additional occurrences of higher volume losses could provide a reliable, early warning sign to the bulls.

Last Friday's weakness presented us with a pullback buying opportunity we've been patiently waiting for. Complementing our recent entry into U.S. Natural Gas Fund (UNG), which approximately follows the price of the natural gas futures, we bought First Trust Natural Gas Index (FCG), which is exclusively comprised of individual stocks related to the production and exploration of natural gas. Since breaking out above a band of horizontal price resistance earlier this month, FCG has been showing considerable relative strength to the broad market. Month-to-date, FCG has zoomed 11.4% higher. Comparatively, the S&P 500 has gained 2.0% during the same period. We bought FCG last Friday, when it bounced off support of its 20-day exponential moving average on the short-term pullback. UNG was unchanged, but remains poised to blast through its 50-day MA. Our entry into FCG is shown on the daily chart below:



Government T-bond ETFs are starting to see positive inflows of funds, and may present short-term trading opportunities this week. The popular iShares 20+ year Treasury Bond Fund (TLT) is now testing key resistance of its prior highs, and closed the week at a four-month high. Since TLT closed just a few cents above its breakout level, a buy entry near the current price is acceptable, as is any slight pullback in today's session. For a quick momentum trade, TLT could be sold into strength, as it tests its 200-day MA (around $100.40). For such a short-term trade, a tight stop is required. The $97 area would give TLT enough "wiggle room" below its breakout level, and would also put the stop below short-term support of its 20-EMA on the hourly chart. The daily chart of TLT is shown below:



Last week's correction positions the S&P 500, Nasdaq Composite, and Dow Jones Industrial Average to open today's session right at key support of their 20-day exponential moving averages (EMAs). The beige line on the chart of the S&P 500 below represents the 20-day EMA:



In mid-August and early September, the major indices pulled back to briefly "undercut" their 20-day EMAs (circled in pink), but subsequently rallied to new highs of the year both times. If that same pattern repeats itself, one might expect to see a bit of deliberation over the next few days, followed by a bullish reversal towards the end of the week. Obviously, there's no guarantee the current pullback to the 20-day EMAs will again lead to new highs of 2009; however, one also can't blindly assume stocks will correct much further in the short-term. But if the market fails to recover as easily as it did during previous corrections, one could blame it on long-term resistance of the 20-month moving average of the S&P 500 (which we pointed out in a recent issue).

In the very short-term, our bias is basically neutral, at least until we see how the major indices react to the current test of their 20-day EMAs. Yet, despite our "wait and see" approach to the broad-based ETFs right now, specific industry sector ETFs with relative strength or weakness can still be selectively traded. On the short side, oil-related ETFs continue to show relative weakness. We're also monitoring financial ETFs for potential failed breakouts. On the long side, we like the relative strength in natural gas ETFs, as well as the developing breakouts in the fixed-income (bond) ETFs. Also, keep an eye on the U.S. Dollar Index (UUP), which may stealthily be finding an important bottom. Finally, Semiconductor HOLDR (SMH) is coming into support of its 50-day MA, which may present a swing trade on the long side (assuming the broad market holds up).

Open ETF positions:

Long - UNG, FCG, DGP, GDX, DBB
Short - USO, DUG (inversely correlated 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.