After a three-day bounce off the August lows, stocks suffered a sharp round of broad-based selling yesterday, causing the major indices to resume last week's downtrend. The Dow Jones Industrial Average fell 1.4%, as the S&P 500 Index and Nasdaq Composite posted identical losses of 1.7%. The small-cap Russell 2000 Index and S&P Midcap 400 Index shed 2.7% and 1.7% respectively. A bit of price stabilization in the afternoon enabled the broad market to recoup a portion of its morning losses, but the main stock market indexes still closed near the bottom quarter of their intraday ranges.

Turnover rose sharply across the board, causing both the S&P and Nasdaq to register a bearish "distribution day." Total volume in the NYSE jumped 17%, while volume in the Nasdaq increased 24% above the previous day's level. The losses on higher volume were indicative of selling among mutual funds, hedge funds, and other institutions. Although the S&P and Nasdaq gained on higher volume just three days ago, yesterday's volume of the selloff was substantially higher than it was on the "accumulation day" of August 17. Furthermore, it was the fifth "distribution day" for both the S&P and Nasdaq in recent weeks. A healthy market can generally absorb the supply from a few days of institutional selling, but the presence of five or more "distribution days" within a four-week period often precedes a substantial decline in the stock market.

Yesterday's selloff caused both the S&P 500 Index and Dow Jones Industrial Average to slide back below their 50-day moving averages. Both indexes also set new closing lows for August. The Nasdaq Composite, which failed to reclaim its 50-day moving average when the S&P and Dow did, settled just a few points above this month's closing low. Overall, the near-term technical picture of the broad market apparently does not bode well for the bulls. Therefore, dipping a toe in the water on the short side of the market right now could be a decent proposition; another wave of selling in the broad market could spark bearish momentum that could send the major indices back down to test their July 2010 lows. At that point, astute traders could look to take profits on any near-term short positions. Nevertheless, since the major indices are still near the middle of their multi-month trading ranges, this is not the time to be heavily exposed on either side of the stock market. This is further compounded by the fact that today is monthly options expiration day, which is typically marked by erratic price action.

In yesterday's session, we sent an Intraday Trade Alert to subscribers, informing of an entry into a new position to take advantage of the developing weakness, through buying the inversely correlated UltraShort Semiconductor ProShares (SSG). We've been discussing the relative weakness in the semiconductor sector over the past several days, and we liked the reward/risk ratio of buying SSG when it moved above its two-day high and 200-day moving average. Our entry point is annotated on the daily chart of SSG below:



There are periods in the stock market where conditions are prime for aggressively focusing on making profits, and there are times when a trader's primary goal should merely be capital preservation. With the major indices stuck near the middle of multi-month trading ranges, and volume limping in below average levels, there has been a general lack of follow-through in what would otherwise be decent technical trade setups. As such, it's fair to say this is an environment where traders are ahead of the game if they can merely preserve capital, rather than churning their accounts. Profits harvested from the market could actually be considered a "bonus" right now, and we're fortunate to have such a rather solid "bonus" in this choppy environment.

In our model ETF portfolio, we can't complain about how things are going so far this month. Since August 1, we have closed six ETF trades. Of those, two were scratches (gain or loss of less than $100), one was a winner (DBA), and three were losers (TAN, UNG, DZZ). However, because of our consistent focus on cutting the losers quickly, while letting the winners run, the net sum of those six trades was actually a net portfolio gain of approximately 1%. Additionally, the current, mark-to-market P&L of our four open positions is a further gain of just over 3% (each position is presently showing an unrealized gain since entry). Putting it all together, our model ETF portfolio is showing a gain of more than 4% so far this month (including open positions). Obviously, that's a nice profit in any month, but it especially compares quite favorably to the recent performance of the S&P 500 Index, which is down 2.4% month-to-date. Still, even if your personal trading account is only breakeven this month, and you were disciplined by following your trading plan, you should genuinely feel good about it and pat yourself on the back. Swing trading conditions will eventually improve, especially when stocks make a definitive move out of their dominant, sideways trading ranges. But until that happens, capital preservation is a worthy accomplishment to strive for and maintain. Don't swing for the fences right now, or you'll probably strike out.

Open ETF positions:

Long - TLT, DBA, UUP
Short (including inversely correlated "short ETFs") - SSG

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.