Stocks were pounded relentlessly on Monday as volume expanded to even loftier heights. A rally that took bulls over 320 days to create (the rally that started in September 2010) the bear market has erased in a mere 12 days. For the second time in three days the major indices opened at session highs and closed at the dead lows of the day. All five major indices closed down more than 5.0% with the small-cap Russell 2000 shedding an astounding 9% yesterday. The S&P MidCap 400 plummeted 8.3% as the Nasdaq and S&P 500 were shredded by almost 7.0%. The Dow Jones Industrial Average fared the best but still plunged by 5.6%.

Market internals were ugly. Volume continued moving higher on Monday. This suggests that we have not yet reached capitulation. For the second time in as many days volume on the NYSE was over two times greater than its 50-day volume moving average. Incredibly, volume has increased five consecutive days on both exchanges. On the Nasdaq, turnover climbed by 6.1% and on the NYSE by 9.8%. Further compounding the market's negativity was the spread ratio. By the closing bell the ratio of decling volume to advancing volume had reached a reading of 78 to 1 on the NYSE and 103 to 1 on the Nasdaq. This type of price and volume action is irrefutably bearish and we classify yesterday as both a continuation and distribution day for the broad market.

When market volatility reaches frenetic levels it is generally best to be on the sidelines. Jumping in and swing trading on the short side when the market is in free fall is dangerous because when capitulation comes the counter trend rally is swift and powerful. The rebound following a capitulation move can wipe out days of profits within a few hours. We are very respectful of this fact and have therefore remained on the sidelines for several days now. We caught the initial part of the move and made money. However, we never chase a market. The better strategy is to be patient and wait for setups to form. A common psychological mistake made by traders is to allow regret to invade their trading. Regret is a powerful emotion that is at the root of overtrading, revenge trading and poor trade timing. The bigger the move in a market the bigger the regret suffered by most investors. Such thinking is dangerous. Our strategy is to be patient and continue to wait for the next wave of trading opportunities to "come to us". The problem with chasing the market is not that you can't make money; rather the risk/reward of the trade is out of line. We are methodically scanning the market for the next high probability setups to form. We only want to enter trades with strong risk/reward ratios. Now that the market trend has reversed we are likely to find most opportunities on the short side of the market and are preparing to capitalize on this opportunity.

If there is good news for the market it is that capitulation may soon be at hand. Sentiment readings are reaching extremes. As volume and volatility rise and the market plummets, investor sentiment plummets. In order for a reversal to occur we now need a move that drives virtually all bulls from the market. The market needs an extreme number of bears and virtually no bulls. We are probably very close to that moment but rather than trying to guess we prefer to wait for market action to provide confirmation. Late to the party bears need to be drawn into a short trap and then be punished for their impatient, regret driven behavior. It is after this move that we will consider taking on short positions. Protecting capital is just as important as making money.

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.