The major indices concluded the month of January with another day of substantial losses last Friday, as higher volume indicated continued institutional selling. Stocks initially got off to a positive start, but turned tail after the first hour of trading, and continued lower throughout the rest of the session. The S&P 500, up 1.1% at its intraday high, finished 1.0% lower. Relative weakness in the tech arena caused the Nasdaq Composite to tumble 1.5%. However, the Dow Jones Industrial Average held up relatively well, losing just 0.5%. The small-cap Russell 2000 and S&P Midcap 400 indices shed 1.0% and 1.4% respectively. Each of the main stock market indexes settled finished near its low of the day, week, and month.

Total volume in the NYSE swelled 31%, while volume in the Nasdaq rose 11% above the previous day's level. When stocks were trading higher in the morning, turnover was on pace to be significantly lighter, but volume levels picked up sharply when the broad market subsequently headed south. Such action is the opposite of what investors want to see in a healthy market, as it tells us mutual funds, hedge funds, and other institutions were clearly distributing shares. Since more than half of the stock market's average daily volume is derived from institutional trading, the market's short-term trend is typically determined by the activity of institutions. A daily analysis of the NYSE and Nasdaq price to volume relationship is a great way to see "under the hood" of the market, which provides an accurate snapshot of the market's overall health.

In last Friday's commentary, we illustrated how the S&P 500 might stage a short-term bounce if it rallied above resistance of its hourly downtrend line. On that day's open, the index indeed gapped above that trendline in the first hour of trading, but failed to remain above it. Further, astute traders would have been suspicious of the initial rally attempt because it lacked the confirmation of higher volume. Nevertheless, the S&P could just as easily rally above its short-term downtrend line in today's session. If it does so and sticks, and only if higher volume confirms any rally, swing traders may find a few momentum-based trade setups that have the potential to provide quick profits on the broad market's bounce.

When the main stock market indexes have pulled back substantially off their highs, it becomes much easier to find ETFs exhibiting the most relative strength to the broad market. Specifically, those that remain near their highs, even as the major indices have dropped, can be said to have the most relative strength. Stocks and ETFs so strong that they hold firm when the rest of the broad market drops are usually the first to surge higher when the major indices eventually bounce as well. Therefore, since we could soon see a tradeable bounce in the main stock market indexes, let's take a look at a few ETFs still exhibiting relative strength. Consider putting the following tickers on a watchlist so their performance can quickly be assessed when the broad market catches a bid:









After three straight weeks of losses, the S&P 500 enters the month of February well below support of its 50-day moving average, and approximately 7% below its 52-week closing high from January 19. Trading at its lowest closing level since November 6, the index has also sliced through support of its mid-November to December consolidation. But even though extensive selling has occurred in a short period of time, the current technical picture of the S&P 500 merely resembles its pattern from mid-June to early July of 2009. Back then, just like the present, the S&P fell through its 50-day MA, and traded as low as 7% off its 52-week high. Preceding volume patterns were also negative, as they typically are before a correction begins. Yet, institutional buying returned to the markets, one month after the pullback began, sending the major indices to fresh 52-week highs just a few weeks later. Will history repeat itself this time?

One distinct difference between this correction and the pullback from June/July of 2009 is substantially more leading stocks have broken down. In the June/July correction, most of the strongest stocks held firm while the major indices retraced lower. However, the charts of Nasdaq giants such as Apple Inc. (AAPL) show a different picture this time around. While this does not necessarily mean the dominant uptrend of the past ten months is over, odds are decent this pullback may last a bit longer than others we've seen. Still, even if it does, there will likely be tradeable bounces along the way. Keeping a constantly updated watchlist of stocks and ETFs with the most relative strength, then buying upon the first sign of higher volume gains, is a great way to profit from quick, momentum-based swing trades on the long side.

Open ETF positions:

Long - UUP, FCG, EWJ
Short (including inversely correlated "short ETFs") - (none)

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.