An encouraging start to the week concluded on a rather negative note last Friday, as the main stock market indexes plunged across the board. The major indices gapped lower on the open, then trended steadily lower as the day progressed. The Dow Jones Industrial Average tumbled 2.5%, the S&P 500 2.9%, and the Nasdaq Composite 3.1%. The small-cap Russell 2000 and S&P Midcap 400 indices swooned 3.8% and 3.3% respectively. After erasing a full week of gains in just one day, all the broad-based indexes finished at their intraday lows.

Unfortunately for the bulls, volume swelled alongside of the market's sharp losses. Total volume in the NYSE jumped 33% above the previous day's level, while volume in the Nasdaq ticked 10% higher. The higher volume losses caused both the S&P and Nasdaq to register a bearish "distribution day," indicative of institutional selling. If higher volume accompanies a "down" day after the market has already been trending steadily lower for an extended period of time, it is often points to climactic selling that precedes a bullish reversal. However, since last Friday's higher volume losses occurred at the top of a short-term bounce, mutual funds, hedge funds, and other institutions were apparently selling into strength. We frequently remind traders that a single day of losses on increased turnover, the results of institutional selling, can wipe out a week's worth of gains in a recovering market; that's exactly what happened last Friday.

In the July 16 issue of The Wagner Daily, we said the SPDR Gold Trust (GLD) was in a precarious position, poised to break down. Specifically, we said GLD was "stuck below resistance of its 50-day moving average. The 20-day exponential moving average crossed below the 50-day moving average two days ago, which is another bearish signal. Now, if GLD drops below its July 14 low of $117.59, it will trigger a valid short entry point that seeks to take advantage of a correction. A realistic price target would be support of the 200-day MA, presently at $111.43." Gapping sharply lower last Friday, GLD indeed appears to be headed for a substantial correction. As gold is frequently viewed as a "safe haven" in bearish environments, it was notable that GLD still sold off alongside of the stock market. Going into today, a break below the prior day's low could cause the shiny ETF to very rapidly slide to its 200-day MA:



Also in our most recent commentary, we pointed out the relative strength in the Semiconductor HOLDR (SMH), which had rallied to test its June 2010 high ahead of the major indices. Last Friday, SMH sold off alongside of the broad market. However, with support of its 20, 50, and 200-day moving averages just below, we viewed the pullback as a low-risk entry point to buy it. As such, we sent an Intraday Trade Alert to subscribers, informing them of our new entry into SMH:



In our July 15 commentary, we pointed out three international ETFs showing relative strength to the U.S. markets (EWS, BRF, and IDX). The iShares Thailand Index (THD) is another Southeast Asian ETF that may soon break out to the upside. Last month, we bought the pullback in THD and subsequently sold for a nice profit. However, it has remained on our radar screen for potential re-entry, and has been consolidating in a tight, sideways range, near its recent highs. The setup for buy entry is annotated on the daily chart below:



Throughout last week, we focused our attention on key resistance levels the main stock market indexes were forced to contend with. The S&P 500 had run into its 50-day moving average, the Dow was unable to get back above its 200-day moving average, and the Nasdaq had to deal with both the 50 and 200-day moving averages. On Friday, the pressure of these overhead resistance levels was realized, causing stocks to get whacked. Going into this week, we would not be surprised to see bearish follow-through that causes the major indices to slide back down to test their July lows. However, as we've been discussing, stocks may be more likely to trade in a wide, sideways range in the intermediate-term, rather than moving sharply in either direction. As such, it may be wise to continue avoiding ETFs that track the broad-based indexes (SPY, QQQQ, DIA, etc.). Instead, focus on ETFs with a low correlation to broad market direction, or at least specific industry sectors exhibiting relative strength (for long positions) or relative weakness (for short sales). Quarterly earnings season really starts heating up this week, so stay alert and prepared for high volatility.

Open ETF positions:

Long - DBA, TLT, UNG, SMH
Short (including inversely correlated "short ETFs") - GDX

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.