The deliberation patterns in the main stock market indexes followed through to the downside yesterday, as stocks sustained substantial losses across the board. Throughout yesterday morning, stocks chopped around in a range-bound, non-committal channel, but a sell-off just before mid-day caused the major indices to slide to their previous day's lows, which they subsequently slid below later in the afternoon. The Nasdaq Composite fell 0.8%, the Dow Jones Industrial Average 0.9%, and the S&P 500 1.0%. Small and mid-caps showed relative weakness again. The Russell 2000 and S&P Midcap 400 indices tumbled 2.1% and 1.5% respectively. All the broad-based indexes closed near their intraday lows.

Total volume in the NYSE increased by less than 1%, while volume in the Nasdaq rose 16% above the previous day's level. The losses on higher volume technically caused both the NYSE and Nasdaq to register bearish "distribution days" yesterday. However, trading in the Nasdaq was artificially distorted by the volume surge in 3Com Corp (COMS), which traded more than 220 million shares on news it was being acquired by Hewlett Packard (HPQ). Even though the higher volume losses in both exchanges pointed to a bit of institutional selling, trading in both exchanges still remained below average levels. In the NYSE, declining volume exceeded advancing volume by a margin of nearly 6 to 1, indicating the selling was broad-based. The Nasdaq adv/dec volume ratio was negative by just 2 to 1.

Yesterday's session was weighed down by strength in the U.S. dollar, which pressured oil and other commodities. We've discussed several times in recent weeks how the dollar has had a direct, inverse relationship to the price of equities, and that once again was the case yesterday. The greenback now appears to be finding support, near its prior lows, against a variety of foreign currencies. Below is the daily chart of CurrencyShares Euro Trust (FXE), which tracks the price of the euro versus the U.S. dollar:



Yesterday's sharp sell-off in FXE occurred after it rallied off support of its 50-day MA the previous week, and was consolidating near resistance of its prior high. If FXE slides back down to its 50-day MA so quickly after bouncing off it, and fails to hold support, a short-term "double top" will be in place. This would likely have negative implications for the equities markets, just as the late-October strength in the dollar pressured stocks as well. Other currency ETFs now have a similar pattern as FXE, including the U.S. Dollar Bear Index (UDN). Until recently, we followed the U.S. Dollar Bull Index (UUP) as a proxy for the strength of the dollar. However, since the strange event of November 5, when the issuer apparently "ran out of shares," UUP has been trading with a premium that artificially distorts the actual value of the ETF. Therefore, for more accurate tracking of the U.S. dollar, one might consider tracking the inversely correlated UDN instead.

In yesterday's commentary, we illustrated how the laggard Russell 2000 Index had run into resistance of its 50-day moving average, and explained why the index could be sold short if it fell below the previous day's low and 20-day EMA. With a percentage loss that was more than double yesterday's losses in the S&P, Dow, or Nasdaq, the Russell indeed fell below its November 11 low, and continued to demonstrate bearish divergence. On the longer-term weekly chart of the Russell 2000, it's apparent that Wednesday's rally into the 50-day MA also coincided with the index bumping into new resistance of its prior uptrend line off the March 2009 low. Take a look at the weekly chart of iShares Russell 2000 (IWM):



The uptrend line shown on the chart above is now resistance because one of the most basic tenets of technical analysis states that prior level of support becomes the new level of resistance, after the support is broken. Yesterday's sharp reversal lower coincided with the Russell running into that weekly uptrend line. As per our plan, we bought the inversely correlated UltraShort Russell 2000 ProShares (TWM) as soon as the Russell 2000 Index fell below its prior day's low.

In addition to TWM, we also initiated a new short position in the Regional Bank HOLDR (RKH), which reversed lower after "overcutting" resistance of its 50-day MA yesterday. Financial ETFs have been one of the weakest industry groups over the past month, as most have barely bounced after falling to test support of their prior "swing lows" from early October. Within the broader financial arena, regional banks and securities broker-dealers seem to be showing the most relative weakness; hence the entry into RKH. On the chart of RKH below, notice how the ETF is still well below its October high, even though the S&P 500 is now testing its 52-week high. If the broad market pulls back in the near-term, financials could lead the way lower again:



The iShares U.S. Broker-Dealers (IAI) has also been a major laggard since the broad market's rally off the November 2 lows. As with RKH, notice that IAI may be stalling after kissing its 50-day MA:



Upon scanning hundreds of ETF charts last night, we noted a vast majority now have similar chart patterns. Most appear to be stalling after approaching resistance of their prior highs from mid-October. The weaker ones, such as TWM, RKH, and IAI, are deliberating as well, but are still well off their prior highs. Overall, we found more short setups than quality long setups. However, further negative price and volume confirmation is required in order to make the argument for aggressively getting short here. Although we entered two new short positions yesterday, we did so with only HALF our normal share size, and therefore half the capital risk. Unless additional bearish momentum materializes, we will simply maintain our small share size. Even if stocks pullback further in the coming days, they could easily find support at the lows of the November 9 "gap up." It's starting to look more likely the sideways trading range scenario we recently discussed may be coming into play.

Open ETF positions:

Long - (none)
Short - RKH, TWM, TBT (TWM and TBT are inversely correlated "short ETFs" we're long; only half size)

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.