After jumping higher out of the starting gate, the S&P 500 briefly moved above the upper channel resistance of its sideways range that has been intact for the past three weeks, but the breakout attempt failed, causing stocks to drift right back down. By mid-day, most of the major indices had fallen into slightly negative territory, but the broad market stabilized and oscillated in a tight, horizontal range throughout the rest of the day. Tech stocks showed a bit of relative strength, enabling the Nasdaq Composite to finish 0.4% higher. The S&P 500 was unchanged and the Dow Jones Industrial Average slipped 0.2%. Small-caps showed bullish divergence for a second straight day, helping the Russell 2000 Index to gain 1.2%. The S&P Midcap 400 advanced 0.7%. The major indices settled around the bottom third of their intraday ranges.

Total volume in the NYSE was 9% lighter than the previous day's level, while volume in the Nasdaq eased 3%. The slower turnover in both exchanges prevented the Nasdaq from registering a bullish "accumulation day," and also held volume in the index below its 50-day average level. In the Nasdaq, advancing volume exceeded declining volume by a margin of 2 to 1. The adv/dec volume ratio in the NYSE was positive by 3 to 2, despite a flat close in the S&P, and slightly negative finish in the Dow.

In our November 30 commentary, we illustrated how the previous day's large losses in the stock market (sparked by the now-forgotten Dubai World news) coincided with the CBOE Volatility Index ($VIX) coming into key support around the 20 level. We also suggested that whenever the $VIX next approached that level, it would be another warning sign to be extra cautious on the long side of the market. Now, just three days later, the "fear index," as the $VIX is affectionately called, has already drifted back down to approach support of its recent lows. As merely a confirming indicator, this certainly does not imply the market will now make a big move lower, but it does suggest the market is again showing low levels of fear and high levels of complacency. . .the perfect recipe for a correction that catches people off guard:



On November 19, we discussed how the DJ Transportation Average ($DJT), a key component of Dow Theory confirmation, was at a technical "make it or break it" level that would soon have a significant impact on the direction of the major indices. After drifting lower for less than two weeks, the transports have risen back up to test a pivotal resistance level that has acted like a brick wall for the sector in recent months. The chart of iShares DJ Transportation Average (IYT), a popular ETF proxy of the $DJT, is shown below (click here to review our initial assessment of IYT, from our November 19 commentary):



In yesterday's Wagner Daily, we said of the S&P 500's recent price action, "Because of the trading range condition, we must now be prepared for the possibility of a few down days that take the index down towards lower channel support, at the 1,083 area. Of course, a convincing gap above the high of the range, on today's open, could quickly make history of the recent range-bound channel." After the market opened, the S&P 500 indeed moved above the high of its recent range, but failed to convincingly do so, stalling shortly thereafter. This is shown on the hourly chart of the S&P 500:



Circled in pink, notice the S&P popped its head above resistance of the 1,113 level by just 2 points, stayed above that resistance for just one hour, then fell back into its prior range. This is what is commonly referred to as a "stop run," as many traders set their buy stops to enter new positions, as well as cover shorts, just above obvious levels of price resistance. While buying breakouts can be a very profitable strategy, yesterday's action in the S&P 500 was a good reminder of two things: the benefit of setting stops with enough "wiggle room" beyond clearly-defined areas of support/resistance and the importance of quickly exiting a position that fails to hold above its breakout on the same day as entry. Given the trading-range pattern of the S&P 500 over the past several weeks, it would not surprise us to see the index now drift back down to support of the 1,083 area. However, a closing price above yesterday's high, in today's session, would be rather bullish.

Yesterday, iShares Nasdaq Biotech (IBB), which we bought on December 1, confirmed the breakout above its five-month downtrend line by rallying to close above resistance of its mid-November "swing high." Biotechs have begun showing relative strength over the past several days, indicative of the sector rotation we recently suggested. The Semiconductor HOLDR (SMH) tested the key line of horizontal price resistance discussed in yesterday's newsletter, but failed to close above it. We'll continue watching the performance of the semis for a potential buy entry into SMH. The iShares Japan Index Fund (EWJ) consolidated with an "inside day" yesterday, and we're still monitoring it for potential buy entry on a pullback. The short setup in Oil Service HOLDR (OIH), as per yesterday's analysis, triggered for entry after the ETF fell below its December 1 low.

Open ETF positions:

Long - IBB, FCG
Short (including inversely correlated "short ETFs") - RKH, OIH

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.