After tumbling 7 to 9% in just six sessions, the major indices staged a decent bounce last Friday, but the broad market still closed sharply lower on the week. Stocks initially gapped substantially lower, but this time the bulls reversed opening losses within the first thirty minutes of trading. The main stock market indexes subsequently continued higher into mid-day, drifted slightly lower in the afternoon, then moved back up into the closing bell. The Nasdaq Composite advanced 1.1%, the Dow Jones Industrial Average 1.2%, and the S&P 500 1.5%. The small-cap Russell 2000 and S&P Midcap 400 Index rose 1.5% and 1.6% respectively. Stocks closed off their best levels of the day, but near the upper quarter of their intraday ranges.

Total volume in the NYSE increased 9% above the previous day's level, while volume in the Nasdaq edged 1% lower. It's positive that higher turnover accompanied last Friday's gain in the S&P 500, but the increase was likely attributed to it being a monthly options expiration day. It also would have been better if trade had picked up in the Nasdaq as well. Nevertheless, market internals were solid. In the NYSE, advancing volume beat declining volume by a wide margin of 9 to 1. The Nasdaq adv/dec volume ratio was positive by 3 to 1.

There's a decent possibility last Friday's bounce will carry the major indices higher in the near-term. Taking an updated look at the daily chart of the benchmark S&P 500 Index, we see resistance of a month-long downtrend line, between resistance of the 20 and 50-day moving averages, which could serve as a realistic, short-term price target if stocks follow through on last Friday's bullish reversal. If the S&P 500 can follow through to the upside this week, we at least would expect a bounce to (or probe above) the 20-day EMA. A bounce to the 50-day MA is also a possibility, but the S&P may have a tough time dealing with a declining 20-day EMA, as well as its downtrend line (around 1,140). This is shown on the daily chart of the S&P 500 below:



Although stocks may bounce higher over the next week or two, we see no technical evidence to suggest the market is ready for a meaningful advance. A more likely scenario is stocks undergoing a month (or more) of range-bound action, with a few false breakouts and breakdowns along the way. Furthermore, now that the intermediate-term trends of the main stock market indexes have reversed to the downside, the best overall plan of action may be to initiate new short positions on ETFs with relative weakness, whenever they bounce into major resistance levels. One such ETF that fits the criteria is U.S. Oil Fund (USO), a commodity ETF that tracks the price of the crude oil futures:



Since a prior level of support becomes the new resistance after the support is broken, major horizontal price resistance should now be found on USO at the $35.20 area. However, downtrending ETFs usually probe above the obvious levels of resistance before resuming their downward trends. As such, a bounce to the $35.50 to $36 range is a better target area for new short entry into USO. The descending 20-day EMA (the beige line) will also provide further resistance around $36. With a short entry near that level, one might consider a protective stop above the 200-day MA (the orange line), around the $38.50 area. If USO bounces that high, it will have moved beyond its 61.8% Fibonacci retracement level (from the May high to low). Therefore, we would no longer want to be short if that happens. Subscribers with non-marginable cash accounts could alternatively consider buying an equivalent pullback to support in the inversely correlated crude oil ETFs (SZO, DTO, SCO), instead of selling short USO.

Another ETF that has demonstrated clear relative weakness throughout the market's recent decline is iShares Basic Materials Index (IYM). While many ETFs are still holding above their intraday lows of May 6, IYM already broken down below its prior low on May 20. On May 19, we closed a short position in IYM, locking in a large gain, because it hit our downside profit target. However, since IYM continues to show considerable weakness, we like the setup for possible re-entry on the short side. Take a look at the annotated daily chart below:



With this setup, a bounce that probes above major resistance of the 200-day MA provides a positive reward-risk ratio, in anticipation of IYM making another leg lower. The $59 to $60 area is an ideal area to initiate a new short position. As with the USO setup, the descending 20-day EMA should provide further resistance, as well as the 50-day MA above that. A protective stop should be no higher than 10 to 20 cents above the swing high of $62.99. If the market's new intermediate-term downtrend resumes after bouncing, IYM should continue to show downside leadership.

As for long setups, there are very few ETFs to consider at current prices because we don't enjoy catching falling knives -- ETFs that haven't at least shown some type of price stabilization and significant bottoming pattern. Nevertheless, a few specialty ETFs could be considered on a pullback entry. Treasury bond ETFs (TLT, IEF, SHY, etc.) have all shown strength as a "safe haven" rotation of institutional funds. The U.S. Dollar Bull Index (UUP) is another possibility on a pullback that "undercuts" support of its 20-day EMA (around $24.50 to $24.60). Until this past week, Gold (GLD) was looking pretty good, but it too has since retraced a bit too steep. Overall, the long side of the market may now be best for quick, ultra short-term traders who trade intraday momentum and relative strength. However, since the focus of this newsletter is ETF trades with an average holding time of several weeks, waiting for new short entries on a bounce is our primary plan right now.

Open ETF positions:

Long - SLV, UNG
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.