Monday's bearish, intraday reversal picked up momentum yesterday, as selling intensified across the board. Stocks opened slightly higher, drifted in a sideways range throughout most of the day, then again plunged lower in the final ninety minutes of trading. The Nasdaq Composite shed 1.2%, the Dow Jones Industrial Average 1.4%, and the S&P 500 1.6%. The smal-cap Russell 2000 and S&P Midcap 400 indices tumbled 2.1% and 2.2% respectively. Unlike the previous day, in which the broad market bounced in the final minutes of trading, each of the main stock market indexes closed at its low of the day.

Total volume in the NYSE was 3% lighter than the prior day's session, but volume in the Nasdaq ticked 5% higher. The Nasdaq's loss on increased volume caused the index to register a bearish "distribution day." The presence of institutional selling so soon after a bullish follow-through day is not an encouraging sign for the market's fledgling recovery attempt. Nevertheless, despite the faster pace of trading in the Nasdaq, volume in the exchange remained well below its 50-day average level. Many traders and investors likely remained on the sidelines ahead of today's upcoming Fed announcement on interest rates and economic policy.

In the June 21 issue of The Wagner Daily, we pointed out bullish trade setups in iShares 20+ Year T-Bond (TLT) and U.S. Dollar Bull Index (UUP). At the time, we were stalking TLT for potential buy entry on a breakout above the upper channel of its "pennant" formation. With UUP, which had just "undercut" its prior swing low, we were looking for a buy entry above the previous day's high. Two days later, in yesterday's session, both ETFs triggered our buy entries. Updated charts of TLT and UUP are shown below:





Also in our June 21 commentary, we said, "Depending on how one looks at it, one could legitimately argue recent price action in the broad market has either been bullish and constructive, or disappointing and in danger of rolling over again. At this stage, it's merely a matter of perspective." Fast forwarding two days later, the bears are apparently regaining the upper hand, as stocks are indeed starting to roll over again. With the losses of the past two days, all the major indices have failed to hold above their prior highs from late May, invalidating the recent trend reversals off the lows. But perhaps more concerning is each of the major indices is now forming a well-defined right shoulder of a bearish "head and shoulders" pattern on its weekly chart. Below, we've annotated the pattern on the weekly chart of the S&P 500 SPDR (SPY), a popular ETF proxy for the S&P 500 Index:



Notice the high of the right shoulder is slightly lower than the high of the left shoulder. This is a bearish sign that increases the likelihood downside follow-through, as it indicates declining buying interest during the formation of the right shoulder (compared to the left shoulder). Because the neckline of this "head and shoulders" (the dashed horizontal line) is nearly perfectly formed, a breakdown below this month's lows would confirm the bearish pattern. If that happens, the projected decline is equal to the distance between the top of the head and the neckline. That equates to an approximate 14% decline below the neckline (around $90 for SPY or the 895 level for the S&P 500 Index).

With the major indices still trading above their June lows by at least several percent, it's too premature to spend much time talking about downside price targets. However, given the high volatility of recent months, it would not be unrealistic for stocks to break down to new lows within just a session or two. In case that happens, it's prudent to be prepared. Still, the main factor likely to determine the market's next move in the coming days is the reaction to this afternoon's 2:15 pm FOMC decision on interest rates and economic policy going forward. Economists don't expect a rate change, nor a changing of the language saying rates will be kept low "for an extended period of time." As always, it's only the market's reaction to the Fed announcement, not what the Fed actually says today, that matters. Furthermore, the knee-jerk reaction and high volatility we will likely see in the afternoon is rarely the market's real reaction, which usually comes about two days after a Fed announcement.

Open ETF positions:

Long - UNG, TLT, UUP
Short (including inversely correlated "short ETFs") - USO

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.