Gapping higher on the open, stocks got off to an encouraging start yesterday, but a subsequent lack of bullish momentum held the major indices in an extremely tight, horizontal range throughout most of the day. A bit of selling pressure in the final two hours of trading erased most of the market's earlier gains, causing the main stock market indexes to finish with mixed results. Scoring its sixth consecutive day of gains, the S&P 500 finished 0.4% higher. The Dow Jones Industrial Average edged 0.2% higher, but the Nasdaq Composite was unchanged. The small-cap Russell 2000 slipped 0.2%, as the S&P Midcap 400 advanced 0.1%. The major indices closed near, or slightly below, the middle of their intraday ranges.

Total volume in the NYSE eased 4%, while volume in the Nasdaq was 7% lighter than the previous day's level. In both exchanges, it was the lowest volume day in months. As mentioned yesterday, the lighter than average turnover in recent days gives cause for the bulls to be extra alert. Most likely, institutions will start returning to the market as key corporate earnings reports are announced throughout this week. Their reaction to the latest quarterly numbers will determine the direction of the market's next substantial move, which will likely be accompanied by a high-momentum volume surge.

Right now, the state of the entire stock market is best summed up by looking at a daily chart of the S&P 500 SPDR (SPY), a well-known ETF proxy of the broad-based S&P 500 Index:



Since bouncing off support of its 50-day MA (the teal line) at the beginning of the month, SPY has logged six straight gains. This puts SPY right at a clear test of its prior highs from last month. The charts of the Dow Jones DIAMONDS (DIA) and Nasdaq 100 Index (QQQQ) are similar, though the latter is lagging slightly. Obviously, it's bullish that SPY has so quickly and easily been able to climb back to its September highs after pulling back to its 50-day MA, but one must be aware of the sharply declining volume that's accompanying the rally. In and of itself, the light volume is not a reason to blindly close long positions. Rather, it's simply a yellow warning flag that short-term bullish momentum may be diminishing.

Our current plan of action is to maximize profits in our existing winning long positions (DGP, FCG, DBB) by continuing to trail stops higher as the short-term 10-day moving averages move higher. As for new trade entries, we'd first like to see the major indices undergo just a near-term correction before deploying additional capital on the long side. Waiting for a near-term correction, either through a modest pullback or a few days of price consolidation, will provide us with much more positive reward-risk ratios for new buy entries. Conversely, entering new trades after a six-day rally into resistance of the 52-week highs carries a substantial risk of positions immediately being put under pressure at the first sign of a market correction.

The good thing about the major indices so neatly trading right at their prior highs is it's easy to spot relative strength amongst leading sector ETFs. Basically, any ETF already trading above its September high, at a new 52-week high, is determined to have relative strength to the broad market. Conversely, any ETF still trading substantially below its September high is probably showing relative weakness. In yesterday's commentary, we illustrated two international ETFs with relative strength (RSX and EWZ), so we'll wrap today's newsletter with a few more charts of strong ETFs to put on your watchlist for potential buy entry on a pullback. Remember, no chasing the current prices:









Open ETF positions:

Long - DGP, FCG, DBB, UNG
Short - MOO

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.