Stocks rallied on Friday recovering some of the early week losses. Equities gapped at the open, consolidated for most of the day, and closed at the highs. However, there was divergence in the market as the higher beta indices outperformed blue chips by a wide margin. The small-cap Russell 2000 and the S&P MidCap 400 led all indices, as both posted gains of just over 2.0%. The Nasdaq put in a strong performance as it closed 1.6% higher. The S&P 500 ended the session up 1.1%, while the Dow Jones Industrial Average was the day's laggard. The Dow finished higher by a slim 0.5%.

Although stocks performed well, market internals were mixed. Trade was light across the board. Volume was down across the board. Turnover on the Nasdaq fell 10.5%, while on the NYSE it plunged over 23.0%. Still, the advancing volume to declining volume ratio was strong across both indices, as it ended the day at 5.8 to 1 on the NYSE and 6.3 to 1 on the Nasdaq.

We were stopped out of our short positions in both EWW and BZQ on Friday. We had already exited half of the BZQ position in the previous session because we didn't like the price and volume action. In Friday's newsletter we provided the following commentary on EWW, "...we want the trade to go in our favor quickly or we want out. This strategy only works if the potential reward is substantially higher than the potential risk (generally 4:1 or better) and the ETF is exhibiting relative weakness". Although this trade did not work, minimal capital was put at risk and the payout potential was high. We can always reenter the trade should circumstances permit.

The Select Materials S&P SPDR ETF (XLB) undercut its 50-day EMA last week and is setting up for a potential reversal. Ideally, we would like to see XLB consolidate along the 50-day MA for several sessions and break out from this newly formed base. The black candlesticks and large black arrows represent what we consider to be a more ideal rally scenario. However, we wouldn't be surprised to see this ETF move back above the 3-day high of $39.12 for a quick rally. "Whipsaw" price action is not generally favorable for sustained rallies. A breakout from an established base is generally a more favorable setup for a sustained rally.



The MSCI Canada Index Fund ETF (EWC) showed relative strength during last week's selloff. Despite poor market conditions EWC held its 20-day EMA. A move above $33.29 on strong volume may provide a long entry trigger for this ETF. As with XLB, we would prefer to see several days of consolidation prior to a breakout. We are monitoring EWC carefully as a possible long candidate.



The iShares MSCI South Korea Index ETF (EWY) has recently broken its uptrend line that began in July of 2010. A rally back into resistance near the 20-day EMA could present a shorting Opportunity in this ETF. We are monitoring EWY carefully for a possible short entry.



When volatility hits the market, sharp reversals and gaps are to be expected. Therefore, if a trade moves against us we prefer to exit quickly and wait for or find a better setup. Further, this type of price action tends to nullify many potential setups and we prefer to remain patient rather than overtrade.

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.