In yesterday's commentary, we said, "Although a healthy market typically absorbs a few 'distribution days' without negative effect, the presence of five more days of higher volume losses is a valid warning sign to the bulls that a correction may be just around the corner." Monday's fifth day of institutional selling in recent weeks was indeed a legitimate warning sign, as stocks followed up Monday's session with a broad-based plunge that caused each of the major indices to tumble approximately 2%. After failing to recover from opening weakness, the broad market swiftly dropped into mid-day, attempted to recover in the early afternoon, then rolled back over to new intraday lows into the close. The Dow Jones Industrial Average slid 1.9%, the Nasdaq Composite 2.0%, and the S&P 500 2.3%. The small-cap Russell 2000 and S&P Midcap 400 indices suffered identical losses of 2.4%. All the main stock market indexes finished near their worst levels of the day.

Turnover jumped across the board, as institutional traders rushed for the exit doors. Total volume in the NYSE swelled 37%, while volume in the Nasdaq rose 16% above the previous day's level. In both exchanges, trading was also well above 50-day average levels. The stock market's higher volume losses caused both the S&P and Nasdaq to register another bearish "distribution day," indicative of heavy selling amongst mutual funds, hedge funds, and other big players. Just as water flowing down a hill always follows the path of least resistance, the stock market does the same. Because institutional trading represents more than half of the market's average daily volume, markets generally go up when institutions are buying, and down when they're selling. Closely monitoring the stock market's underlying price to volume relationship on a daily basis, as we do, enables one to receive early warning signals of potential changes in sentiment, which we pointed out ahead of yesterday's sell-off.

Declining volume in the NYSE trounced advancing volume by a monstrous margin of 20 to 1. At negative 7 to 1, the Nasdaq adv/dec volume ratio was better, but still firmly bearish. These firmly negative ratios tell us yesterday's selling was rather broad-based. Confirming that notion, only 1 of the 25 industry sectors we monitor on a daily basis closed in positive territory yesterday. It was the CBOE Gold Index ($GOX), which gained a whopping 0.3%. However, the actual spot gold commodity performed much better. SPDR Gold Trust (GLD), a popular ETF proxy for the spot gold commodity, rallied 1.7% yesterday. More importantly, GLD broke out above upper channel resistance of a choppy, sideways range that has been plaguing gold since the beginning of the year. This is shown on the daily chart below:



Several times over the past month, we've illustrated that the silver commodity was showing more relative strength than gold. But that was definitely not the case yesterday, as iShares Silver Trust actually slipped 0.3%. We'll be monitoring to see if this was a one-day anomaly, or if gold has reclaimed the near-term leadership of silver. Additionally, we found it rather interesting that GLD gained 1.7% yesterday, even though the U.S. Dollar Bull Index (UUP) jumped more than 1% and closed just a penny shy of its 2010 high. Take a look:



Typically, there is an inverse relationship between the price of commodities and the U.S. dollar, but there are periods of exception. Right now, we may be entering into one of those more unusual periods in which gold and the U.S. dollar simultaneously show strength. This might be regarded as an overall flight to safety, sparked by yesterday's massive decline in the equities markets. Gold is frequently considered defensive, whenever there is fear in the stock market. Meanwhile, the precipitous position of the euro is causing the U.S. dollar to be viewed as a relative safe haven. Yesterday, CurrencyShares Euro Trust (FXE) sliced through support of its recent lows to close at a new 52-week low. Large funds surely must start considering the implications of the world's second most widely-held currency steadily slipping lower month after month.

Since April 16, the day the Goldman Sachs news broke, we've been holding a HALF position of the inversely correlated Financial Bear 3x Shares (FAZ). In the first week after entry, FAZ just chopped around near our entry price. But FAZ surged higher yesterday, breaking out above its 20-day exponential moving average and April 16 "swing high" resistance. When FAZ reversed to rally above its opening high, two hours after yesterday's open, we sent an Intraday Trade Alert to subscribers, notifying them we were adding additional shares to FAZ, taking us up to full position size. Now that FAZ is showing a solid unrealized gain from our entry, we will focus on managing the position for maximum profitability. In the near-term, we're expecting at least a test of the 50-day MA (the teal line on the daily chart below):



In addition to buying FAZ, which is actually a bearish position, we also entered a bullish position in S&P Energy SPDR (XLE), which we snagged on a pullback to support of its breakout level. Although XLE closed slightly below our entry price yesterday, patiently waiting for a retracement to support of its breakout level provided us with a much more positive reward/risk ratio for the trade. Since the market is now apparently in short-term pullback mode, we entered XLE with reduced share size, in order to maintain a more balanced portfolio. We need to see a resumption of relative strength in the energy sector in order to continue holding XLE.

Open ETF positions:

Long - XLE
Short (including inversely correlated "short ETFs") - FAZ

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.