The stock market correction that began last month resumed in a big way yesterday, as the major indices suffered a nasty round of high volume selling, causing them to break support of their recent lows. The broad market gapped about 1% lower on the open, immediately began selling off, and trended steadily south throughout the entire day. The Dow Jones Industrial Average plunged 2.6%, the Nasdaq Composite 3.0%, and the S&P 500 3.1%. The small-cap Russell 2000 and S&P Midcap 400 indices nosedived 3.4% and 3.2% respectively. All the main stock market indexes finished at their dead lows of the day, as well as new lows for 2010.

Turnover rocketed higher across the board, as mutual funds, hedge funds, and other institutions headed for the hills. Total volume in the NYSE surged 40% above the previous day's level, while volume in the Nasdaq swelled 20%. The market's sharp losses on higher trade invalidated the positive volume pattern of Tuesday's "accumulation day," followed by Wednesday's lighter volume pullback. Further, market internals were simply atrocious. In the NYSE, declining volume destroyed advancing volume by a jaw-dropping margin of more than 30 to 1. The Nasdaq adv/dec volume ratio was negative by approximately 10 to 1. These overly negative margins indicate yesterday's selling was extremely broad-based, spreading to every industry sector.

What a difference one day can make. Through the first three trading days of February, it looked as though the stock market was attempting to form a short-term bottom. The price to volume relationship of the S&P and Nasdaq began turning positive, and developing leadership was spotted in one or two industry sectors. But yesterday's freefall dashed the hopes of the bulls. Of technical significance is all of the major indices failed to hold key support of their January 29 "swing lows." In our February 2 commentary, we said of last month's low in the S&P 500, " If the index closes below that level within the next few days, all bets are off for a short-term bottom." Since the S&P closed at 1,063 yesterday, convincingly below the January low of 1,071, the short-term bottoming attempt is officially dead. This doesn't mean stocks won't attempt to re-stabilize in the near-term; rather, it indicates the market needs to start over in terms of looking for a positive price to volume relationship. Traders again need to look for a significant price reversal that's accompanied by higher turnover.

Now that another "lower low" has been formed in each of the major indices, stocks are positioned to make another leg down within the three-week old correction. Looking at the daily charts of the S&P, Nasdaq, and Dow, each index is apparently headed for its next major level of support, the prior lows from late October/early November 2009. With the S&P 500, that next key level of price support will be found at the 1,030 - 1,035 area:



The clear relative strength exhibited by the biotech sector on February 2 and 3, which enabled the ARCA Biotechnology Index ($BTK) to break out to a new 52-week high, was an encouraging sign of developing industry leadership. It prompted us to buy a half position of S&P Biotech SPDR (XBI), when the ETF pulled back to its breakout level on Wednesday. However, sellers left no stone unturned yesterday, causing even the biotech breakout of just two days to get completely destroyed yesterday. Not only did XBI not hold support of its breakout level, it plunged all the way back below its 20-day exponential moving average. Its ugly 4.6% decline caused XBI to hit our stop, just one day after entry. Fortunately, we limited our initial risk by sizing the trade at just half our normal position size.

Although XBI hit our stop, two of our positions zoomed higher yesterday. The balanced portfolio approach we've been discussing in recent days paid off yesterday, as UltraShort Real Estate ProShares (SRS), an inversely correlated ETF, registered a large gain of 7.3%. Our bullish ETF position in the U.S. dollar (UUP) also rallied yesterday. The gains from both of those ETFs countered the decline in XBI, as well as FCG, which stopped out for a very small loss. Now, our only remaining bullish position with a correlation to the equities market is iShares Japan (EWJ), which we will stop just below yesterday's low. Until we see renewed signs of a bottoming attempt, there's again no reason to get long the market. As for existing positions, be sure to honor your protective stops; this market correction is proving to be more extended than others since the uptrend from the March 2009 lows began.

Open ETF positions:

Long - UUP, EWJ
Short (including inversely correlated "short ETFs") - SRS

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.