Very near-term momentum continued to favor the bulls, as stocks snapped back from the prior day's pullback of last Friday's reversal off the lows. After bobbing and weaving through an indecisive, choppy morning, volatility eased in the afternoon, allowing the major indices to score a solid round of gains. The Dow Jones Industrial Average rose 1.5%, the S&P 500 1.3%, and the Nasdaq Composite 1.2%. The small-cap Russell 2000 and S&P Midcap 400 indices climbed 1.5% and 1.2% respectively. Closing near their previous day's highs, most of the main stock market indexes settled just above the middle of their intraday ranges.

Volume ticked higher across the board, causing both the S&P 500 and Nasdaq Composite to register a bullish "accumulation day." Total volume in the NYSE was 14% greater than the previous day's level, while turnover in the Nasdaq increased 8%. The faster trade was positive, as it hinted at buying support among mutual funds, hedge funds, and other institutions. However, overall volume in the NYSE was still below its 50-day average level. Nasdaq volume was marginally greater than average. Strong market internals confirmed the higher volume gains. In the NYSE, advancing volume beat declining volume by more than 6 to 1. The Nasdaq adv/dec volume ratio was positive by nearly 4 to 1.

It was encouraging that stocks followed up Monday's losses with a day of higher volume gains yesterday, as it means the rally attempt from last Friday's reversal is still alive. But so far, we're not seeing the kind of frenzied buying off the lows that followed corrections in the 2009 rally. Because the short-term downtrend lines off the January highs have not yet been breached, the daily charts of the major indices are now showing "bear flags." In order for the charts to more convincingly favor the bulls, traders will now be looking for a clear breakout above yesterday's highs. Such a move would enable most of the main stock market indexes to break out above their multi-week downtrend lines, thereby confirming the recent bullish bias that started with last Friday's reversal. Below, this is annotated on hourly charts of the S&P 500 SPDR (SPY) and Dow DIAMONDS (DIA), two broad-based ETFs correlated to the benchmark S&P 500 and Dow Jones Industrial Average, respectively:





On both charts above, notice how a rally above yesterday's highs would correspond to a breakout above the downtrend lines that have been in place for more than three weeks (the dashed blue lines). If the major indices manage to break out and close above these downtrend lines, the "bear flags" on the daily charts would be invalidated, and the recent rally attempt will be more likely to hold up, at least in the near-term. The immediate upside target would be a quick rally to the prior "swing highs" from February 2 (circled in pink). Upon running into those highs, one might consider selling any long positions into strength, and taking a "wait and see" approach to the stock market's next move.

On Monday, February 8, we bought the S&P Midcap SPDR (MDY), in order to participate in any broad market advance that develops off the recent lows. However, since we bought MDY after just one bullish reversal day, without additional confirmation, we took a rather short-term approach to the trade. Our initial stop was just below the February 5 low, while our exit strategy was to sell MDY into strength of a rally into its February 2 "swing high" (similar to the SPY and DIA charts above). Yesterday's rally gave us an unrealized gain of 1.4 points in the MDY trade, but we have now tightened the stop to near the breakeven level, just below yesterday's low, in order to eliminate our risk in the event the market's fledgling rally attempt fails. Because it is such a short-term, momentum-type trade, we are now trailing a tight stop below support of the uptrending channel of the February 5 lows, using each of the preceding day's lows as a guide. Below, we've annotated our entry, original stop, and new stop on the 15-minute intraday chart of MDY:



This MDY trade is different than most of our other trades, in that we only intended a holding period of about 2 to 5 days. With such a short-term trade, one cannot afford to give the play a lot of "wiggle room," unlike the looser stops of most of our positions. All of the trades in our model portfolio are entered based on technical analysis, but the timeframes sometimes vary from one trade to another. In order to be consistently profitable, it's important to be realize trades of different time frames require slightly different styles of management. For example, because we are currently showing a large gain in U.S. Dollar Bull Index (UUP), which we have been holding for the past month, we're keeping a wider stop, in order to sit through mild pullbacks and allow the profits to ride with the strong trend.

Conversely, because MDY has so much overhead resistance right now, we're taking a more proactive stance to managing the trade, trailing the stop to breakeven as soon as possible, then using the very short-term trendlines to keep trailing it higher. If MDY closes above yesterday's high in today's session, we will again move the stop higher going into the following day. Meanwhile, we're keeping overall capital risk to a minimum by remaining hedged with a bearish position in UltraShort Real Estate ProShares (SRS), which is presently showing an unrealized gain of 10% since our February 3 entry. If the major indices break out above their multi-week downtrend lines within the next day or two, more trade setups may present themselves. But for now, there's not a whole lot of thrilling setups out there, so we're laying low with our three open positions, one bullish, one bearish, and one with a low correlation to the direction of the stock market.

Open ETF positions:

Long - UUP, MDY
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.