One day after closing at new highs of the year, the major indices fell back into their prior trading ranges, as a strengthening dollar and Fed jitters kept the bulls away. After opening lower, the broad market initially reversed higher, closing the opening gap down within the first ninety minutes of trading, but upside momentum subsequently stalled. Thereafter, stocks drifted lower throughout the rest of the day, with increasing selling pressure in the final hour. Both the Nasdaq Composite and Dow Jones Industrial Average fell 0.5%. The S&P 500 and small-cap Russell 2000 each declined 0.6%. Mid-cap issues showed a bit of relative strength; the S&P Midcap 400 Index edged just 0.1% lower. A bounce into the closing bell enabled the main stock market indexes to finish off their worst levels of the day, but still near the bottom quarter of their intraday ranges.

Turnover swelled across the board, causing the S&P and Nasdaq to register a bearish "distribution day." Total volume in the NYSE increased 10% above the previous day's level, while volume in the Nasdaq similarly rose 9%. Although stocks scored a round of higher volume gains on Monday, yesterday's even higher volume losses in the broad market were indicative of moderate selling amongst mutual funds, hedge funds, and other institutions. However, market internals were not very negative. In both exchanges, declining volume exceeded advancing volume by a ratio of just 2 to 1. Over the past month, "distribution days" have outnumbered "accumulation days" by a wide margin, but the resilient major indices continue to consolidate near their recent highs.

Yesterday, we entered two new trades: a long position in Semiconductor HOLDR (SMH) and a long position in the inversely correlated Financial Bear 3X (FAZ). As we've done with all new positions in recent weeks, both were entered with just half our normal share size, in order to reduce risk during a range-bound market.

Last week, we bought and sold SMH for a scratch, as the ETF appeared likely to consolidate a bit longer before moving higher. However, we re-entered SMH yesterday, as the 10-day moving average rose up to provide support, and it rallied above its short-term hourly downtrend line. Because the stock market sold off in the afternoon, SMH closed a bit below our entry price, but is still holding in a tight band of bullish consolidation at its high. The hourly chart below details our entry point, while the daily chart that follows illustrates the bullish consolidation and support of the 10-day moving average:





Our second trade was a buy entry into FAZ, a bearish trade that moves in the opposite direction of the financial sector. We recently covered our short position in the Regional Bank HOLDR (RKH) for a decent profit because the banks appeared to be finding support. But leading stocks in the sector, such as Goldman Sachs, are once again showing relative weakness. It's especially notable that many financial stocks formed bullish reversal candles on Monday, but then fell below the lows of those bullish candlesticks yesterday. On the chart below, notice that FAZ is consolidating in a tight range, holding just above support of its 20 and 50-day moving averages, after an "undercut" below those moving averages two days ago:



If FAZ follows through to the upside (meaning financials follow through to the downside), we're only looking for a short-term price target of the November 2 high (around $24). On the other hand, if the major indices convincingly break out above their current trading ranges and hold, we'll look to close the FAZ trade, while letting SMH ride to the upside. In addition to taking reduced share size with all new positions, risk in range-bound markets can be reduced by trading on both sides of the market -- long ETFs with relative strength, short those with relative weakness.

Though most of the major indices set new closing highs of 2009 on Monday, we cautioned against getting too excited about it because the S&P, Nasdaq, and Dow did not actually break out above the intraday highs of their recent consolidation patterns. Rather, they merely edged out their previous closing highs that were also set while within their choppy, sideways ranges a few weeks prior. As such, we weren't surprised that stocks fell back into their previous trading ranges yesterday. It was just another case of a lack of follow-through -- something we've seen many times, in both directions, over the past five weeks.

Today at 2:15 pm EST, the Fed will announce the government's latest stance on interest rates and economic policy. While virtually nobody is expecting a change in the Fed Funds Rate today, traders will be closely focused on the language regarding future economic policy. Since March, the Fed has pledged to keep interest rates "exceptionally low" for an "extended period" of time. If any part of that language is removed, there could be a sharp, knee-jerk reaction in the stock market. However, as long as those specific, key words remain in place, the market's reaction may be muted. Given that unemployment figures slightly exceeded expectations recently, it will be rather interesting to see if the Fed deems this as significant enough cause for change. As on all Fed days, be prepared for high volatility in the afternoon.

Open ETF positions:

Long - SMH
Short (including inversely correlated "short ETFs") - FAZ

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.