After gapping sharply lower on the open, stocks continued south for first 30 minutes of trading until catching a bid and finding support. Thereafter, the major indices reversed higher into mid-day, but drifted back down in the afternoon, after failing to overcome resistance of their morning highs. The Dow Jones Industrial Average fell 1.3%, the S&P 500 Index 1.5%, and the Nasdaq Composite 1.7%. The small-cap Russell 2000 and S&P MidCap 400 slid 1.2% and 1.6% respectively. The main stock market indexes finished near the lower third of their intraday trading ranges.

Turnover surged across the board, causing both the S&P and Nasdaq to register another bearish "distribution day." Total volume in the NYSE swelled 36%, while trading in the Nasdaq increased 26% above the previous day's level. For the first time in approximately 6 weeks, volume in the NYSE exceeded its 50-day average level.. Turnover in the NASDAQ was also greater than average. Although it's typically bearish when higher volume accompanies sharp losses, increased trade after a substantial selloff in the market is sometimes bullish because it can be representative of stealth institutional buying. At the least, it would be deceiving to say mutual funds, hedge funds, and other institutions were running for the exit doors yesterday. Still, in both the NYSE and NASDAQ, declining volume exceeded advancing volume by a margin of approximately 7 to 1.

In the August 17 issue of The Wagner Daily, we said, "TLT will bump into resistance of its 50% Fibonacci retracement level just above yesterday's (August 16) high. However, given that TLT just broke out yesterday, it's more likely it will rally nearer to the 61.8% Fibonacci level before running into substantial selling pressure. For now, we're planning on selling TLT into strength, locking in a nice gain, at the $108 to $109 area." Yesterday morning, as the stock market sold off, TLT surged higher, moving above the $108 level for the first time since March of 2009. As such, we followed the plan mentioned in our August 17 commentary, and sold TLT into strength as it tested $108. Including monthly dividend distributions at the beginning of July and August, we netted a gain of more than 10 points (and 10%) on the trade. On the weekly chart of TLT below, notice our exit price coincided with an area of horizontal price resistance from March of 2009:



Although TLT is still trending very strongly, it is getting a bit extended away from its 10-day moving average, a reliable level of short-term support for strongly trending stocks and ETFs. Put another way, TLT now appears to be "overbought" on a short-term basis. Since bond ETFs generally have short-lived moves higher, followed by extended period of consolidation, TLT will likely start to trade and consolidate in a sideways range from here. If we see a substantial correction in TLT, perhaps a pullback to its 50-day moving average, we'll consider reentering the trade at a lower price than where we sold yesterday. But for now, we are pleased to have locked in a very nice profit.

In recent weeks, we have pointed out the bullish charts and relative strength of a handful of international ETFs, most of which are located in the Asian region. As the major indices have been selling off recently, many of these ETFs have continued to grind higher, or have simply moved in a sideways range of consolidation. This is a bullish sign, as the next wave of strength in the broad market should enable these international ETFs that have been consolidating to break out above the highs of their recent ranges. One such ETF poised for breakout above its consolidation is PowerShares India Portfolio (PIN). The setup is shown on the weekly chart of PIN below:



After two weeks of choppy, range bound action, the major indices made a technically significant move yesterday, with a confirmed breakdown below horizontal price support levels we discussed in yesterday's newsletter. This increases the odds of further follow-through to the downside, most likely a retest of the July 2010 lows. However, this does not necessarily mean it will happen today, or even with the next few days. Since this market has a way of being choppy and indecisive, we think there's a good possibility stocks will try to stage a short-term bounce and catch the bears off guard, now that they've broken down below an obvious level of support. Thereafter, however, another leg lower could be in the cards. Conversely, if stocks do not bounce from here, a test of the July lows would probably be imminent, providing even greater reward-risk on the long side thereafter, due to major levels of support from the four-month old trading range.

Open ETF positions:

Long - 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.