The major indices begrudgingly edged higher in the morning, floated back down in the morning, then closed near the flat line. The uneventful session caused both the S&P 500 and Nasdaq Composite to finish unchanged, while the Dow Jones Industrial Average slipped 0.1%. Maintaining their recent patterns of relative strength, the small-cap Russell 2000 and S&P Midcap 400 indices each managed to gain 0.2%. The Russell's small advance pushed the index enough to join the S&P Midcap at closing at its highest level of 2010. However, all of the main stock market indexes closed in the bottom quarter of their intraday ranges.

Turnover eased across the board, as institutions backed off to allow stocks to digest their recent gains. Total volume in the NYSE declined 12% below the previous day's level, as volume in the Nasdaq ticked 8% lower. Overall volume in the Nasdaq remained above its average level, but lighter than average in the NYSE. A bit concerning for bulls is that trading in the NYSE has only exceeded its 50-day average pace twice since the rally off the February 5 lows began. Nevertheless, lighter volume on a flat consolidation day that follows a rally is generally constructive because it indicates a lack of heavy selling into strength.

After oscillating in a sideways range for the past six weeks, the Energy sector may be poised for a breakout above its pullback consolidation that carries it back to its January 2010 high. Representative of the pattern shared by most of the energy ETFs is iShares U.S. Energy Sector Index (IYE), whose daily chart is shown below:



With major support of the 200-day moving average (the orange line) converging with the February 25 "swing low," IYE is now positioned to break out above the high of its recent consolidation, which converges with the 50-day moving average (the teal line). Quite simply, a rally above yesterday's high is our trigger point for buy entry. A protective stop could be placed below the February 25 low and 200-day MA (or below the 20-day exponential moving average for a tighter play with shorter time horizon). In addition to IYE, two other popular Energy ETFs are Energy Bull 3x (ERX) and ProShares Ultra Oil and Gas (DIG). Both have patterns very similar to IYE, but are leveraged ETFs. This means they can be traded on a very short-term basis with little ill consequence, but have the longer-term disadvantage of slightly underperforming the underlying index, due to of the daily rebalancing of their derivative portfolios. Nevertheless, traders with a short-term time horizon and/or small trading account might consider buying a breakout in ERX or DIG, rather than IYE. However, our "official" setup in today's newsletter is a potential buy only in IYE.

In the current environment, we prefer buying ETFs that are reversing their downtrends after a pullback (such as our recent entry into FXI), rather than buying breakouts near the highs. While breakout plays can be very profitable in strong bull markets, the S&P, Nasdaq, and Dow have not proven they're capable of moving back to their January 2010 highs without first making another leg lower. As such, we're more comfortable buying bullish trend reversals of formerly strong ETFs that have pulled back. Still, for those of you who are trade with a very rapid time horizon, giving you greater ability to quickly react in the event of a failed breakout, we'll leave you with a potential breakout play to consider for a quick pop if it goes:



Open ETF positions:

Long - FXI
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.