Brushing off the negative knee-jerk reaction to the previous day's Fed meeting, stocks zoomed higher yesterday, but turnover remained tepid. The major indices opened in positive territory, trended higher during the first ninety minutes of trading, then consolidated in a sideways range throughout the rest of the day. The Nasdaq Composite climbed 2.4%, the Dow Jones Industrial Average 2.1%, and the S&P 500 1.9%. An encouraging sign, the Russell 2000 showed relative strength for the second time within the past three days. The small-cap index jumped 3.2%. The S&P Midcap 400 gained 2.4%. Each of the major indices closed at its intraday high.

Yesterday's percentage gains were impressive, but one key element missing from the rally was higher volume. Total volume in the NYSE declined 4%, while volume in the Nasdaq was 4% lighter than the previous day's level. Higher volume would have indicated the return of accumulation amongst mutual funds, hedge funds, and other institutions, but they apparently remained on the sidelines. Since institutional trading accounts for more than half of the market's average daily volume, short-term aberrations in the direction of the stock market are usually short-lived unless there is the confirmation of institutional activity. Nevertheless, market internals were quite strong. In the NYSE, advancing volume exceeded declining volume by a margin of nearly 6 to 1. The Nasdaq adv/dec volume ratio was positive by 9 to 1, indicating rather broad-based buying.

On one hand, yesterday's session was bullish, as the major indices closed above their November 4 highs, a day that finished on a rather negative note. However, the rally still lacked the punch of institutional buying. As we've mentioned several times recently, we don't feel confident jumping back into the long side of the market until the major indices at least register a solid session of higher volume gains. Since the November 2 lows, this hasn't happened. Given the current situation, many traders are probably wondering whether it's now a time to begin re-entering the long side of the market, in anticipation of a breakout to new 52-week highs, OR if the present bounce off the November 2 lows is merely a chance to enter new short positions with a positive reward-risk ratio. Although there are mixed signals, the daily chart of the S&P 500 is now forming the right shoulder of a bearish "head and shoulders" top. Below, we've annotated the "head and shoulders" pattern on the daily chart of the S&P 500 Index (moving averages are removed so you can more easily see the pattern):



If the "head and shoulders" pattern follows through, it means the next major move in the market will be to the downside. However, recall the major indices also formed the same pattern from May to July of this year, but failed to follow through to the downside. Instead, the indices came into support of their "necklines," then promptly ripped to new highs. Obviously, there is a rather valid possibility of this happening again. But one major difference between now and then is that there has yet to be a solid day of accumulation. Almost without fail, significant market reversals from downside corrections are preceded by at least one day of higher volume gains, which subsequently builds on itself.

Right now, the major indices are basically in "no man's land," attempting to recover from their lows of the short-term correction, but so far without conviction on the buy side. As such, it makes sense to be prepared on both sides of the market. It may be a good idea to maintain a watchlist of potential buy candidates if the broad market suddenly surges higher, invalidating the "head and shoulders" pattern on strong volume. Conversely, now is the ideal time to have a list of a few possible short entries to consider if stocks run out of steam and start rolling over again.

So far, there have not been many ETFs that have come across our radar screen as potential buy candidates. Various healthcare ETFs (XLV, IYH, IBB) have been showing relative strength over the past few days, but their intermediate-term chart patterns are showing more relative weakness than other sectors. As such, there's a lot of overhead supply the sector needs to contend with. One of the only major industry sectors with a chart pattern that has not broken down is Energy. Below are the daily charts of two popular energy ETFs, both of which recently found support at their 50-day moving averages, and are now consolidating in a tight range at their 20-day exponential moving averages. Either ETF may be buyable above the high of the past two days, but be sure to maintain a tight stop, in the event of a sudden market reversal:





On the short side, consider ETFs that have already broken down to form "lower lows" (below their early October lows), and are now bouncing into various resistance levels. One such ETF is S&P Metals and Mining (XME). In mid-October, XME formed a "double top" at resistance of its prior highs from September, "undercut" its prior "swing low" last week, and is now bouncing into resistance of its 50-day moving average. XME could be sold short on a breakdown below yesterday's low, but be careful not to jump the gun with a pre-mature entry price:



Financials remain very weak, as illustrated by the charts of the KBW Bank SPDR (KBE) and iShares Securities Broker-Dealers (IAI). We remain long the inversely correlated Financial Bear 3X (FAZ), which is still showing a solid profit, despite yesterday's bounce in the broad market. Below are the charts of KBE and IAI:





With the mixed signals the market is showing us, combined with many charts being in "no man's land," we continue to remain in "SOH mode" (sitting on hands). Our disciplined, patient approach has kept us out of trouble during the market's recent correction, so we're in no hurry to start entering new positions until we get a better read on the direction of the stock market's next move. We'll be prepared, regardless of which way it turns. In the meantime, we'll focus on managing our existing open positions for maximum profitability.

Open ETF positions:

Long - UUP
Short - FAZ, EDZ, TBT (three inversely correlated "short ETFs" 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.