After three days of narrow-ranged, horizontal trading, the major indices gapped sharply higher to close the week at the highest levels since their early February lows. Sparked by a positive reaction to pre-market employment data, stocks jumped out the starting gate, built on their gains through the first hour of trading, then consolidated near their intraday highs throughout the rest of the session. The Nasdaq Composite climbed 1.5%, the S&P 500 1.4%, and the Dow Jones Industrial Average 1.2%. The small-cap Russell 2000 and S&P Midcap 400 indices advanced 2.1% and 1.5% respectively. Each of the main stock market indexes settled at its highest level of the day and week.

Volume rose across the board, enabling both the S&P and Nasdaq to score a bullish "accumulation day," indicative of buying amongst mutual funds, hedge funds, and other institutions. Total volume in the NYSE was 13% greater than the previous day's level, while turnover in the Nasdaq similarly rose 11%. However, despite the increased pace of trading, total volume in the NYSE remained below its 50-day average level. Market breadth in both exchanges was quite strong. In the NYSE, advancing volume crushed declining volume by a margin of nearly 12 to 1. The Nasdaq adv/dec volume ratio was positive by more than 5 to 1.

After a weak start to 2010, stocks found support in early February, then subsequently began working to recover the lost ground. It's now been a month that the major indices have been trending higher, off their recent lows. So far, both the price and volume patterns have not yet exhibited signs of bearishness. However, now that the rest of the major indices are catching up to the breakouts in small and mid-caps, the more closely-watched S&P, Nasdaq, and Dow will soon be testing resistance of their January 2010 highs. As they do, one should be prepared for a bit of turbulence and volatility. The areas of possible contention are annotated on daily charts of the S&P 500, Nasdaq Composite, and Dow Jones Industrial Average below:







This week, traders and investors who bought at stocks at their January highs, and didn't quickly sell thereafter, may be looking to exit long positions into strength. Though it is never advisable for professionals to think in such a way, amateur retail investors often sell at levels "just to break even." This is called overhead supply, which is the reason that technical resistance levels are created. IF the S&P, Nasdaq, and Dow are destined to head back down, resuming the weakness they encountered at the beginning of the year, the January 2010 highs is the logical area where sentiment could start to change.

Obviously, the indices could blast right through their January highs, as the Russell and S&P Midcap indexes recently did. But a more likely scenario is that stocks will first encounter a bit of a pullback, or at least a "shakeout." As such, we're now monitoring our long positions closely, and will be taking a more pro-active stance to position management, just because of the anticipated volatility around the January 2010 highs. This means we may sell winning positions into strength of a sharp move higher and/or trail tighter stops at any onset of weakness. This further quantifies our March 5 commentary, where we specifically said, "If the S&P, Nasdaq, and Dow surge above their three-day highs today, those indexes could soon join the Russell and S&P Midcap at moving back to their January 2010 highs. But at that point, we would actually consider lightening up and/or tightening stops on long positions." So far, all three of our long positions are looking good. If necessary, we'll keep subscribers updated of any stop changes via Intraday Trade Alerts.

Open ETF positions:

Long - FXI, KCE, IYW
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.