Stocks reversed dramatically on Friday to close higher on mixed volume. The day began with a sharp selloff followed by a reversal at the forty five minute mark. The market moved higher until around 1:00 pm and then consolidated at the highs for the remainder of the day. All five major indices closed higher. The S&P MidCap 400, small-cap Russell 2000 and Nasdaq led the advance as they posted gains of 2.7%, 2.6% and 2.5% respectively. The S&P 500 climbed 1.5% while the Dow Jones Industrial Average improved by 1.2%.

For the third time in as many days the session ended with market internals mixed. The Nasdaq saw an accumulation day as volume increased by 3.1% and advancing volume outpaced declining volume by a ratio of 8.0 to 1. However, volume on the Big Board declined by 6.3% while advancing volume topped declining volume by almost 9.0 to 1.

Despite the fact that the broad market trend remains bearish, there is currently a divergence developing between the S&P 500 and Nasdaq that suggests we might see another move higher. We say this with caution due to the volatility in the market and have no desire to enter any long positions. The charts below clearly show this divergence. Notice that over the past four days, there have been two accumulation days on the Nasdaq and no distribution days. This is a short-term bullish signal for the Nasdaq. However, the S&P 500 is presenting a different picture. Over the same four-day period the S&P has witnessed one accumulation day and one distribution day. An accumulation day is defined as a trading session in which both the price action and the volume are higher than the previous day. A distribution day occurs when the price action is lower but the volume is higher than the preceding day. Generally speaking, an accumulation day followed within two or three days by another accumulation day suggests upward momentum (even in a downtrend). This is exactly what has occurred on the Nasdaq. However, when an accumulation day is followed within two or three sessions by a distribution day, this is often considered bearish (during a downtrend) since control of the trend is not being relinquished by bears. Obviously, this is what has occurred on the S&P 500. This divergence in price action suggests that we need to be cautious with our trading over the next several days until the market sorts out the direction of the next move.





We exited our position in BZQ yesterday even though it did not hit its stop. We made a judgment call to close the trade due to the sharp reversal in the broad market. Even if the trade were to be successful it's sometimes best to move to the sidelines when the market reverses so violently against an open position that is not well in the money. We maintained our short position in EWM since it is still well below its protective stop. We will continue to focus our attention on identifying quality short setups into any rallies and may look to trade smaller size and possibly widen our stops as a means of taking into account the wild swings in the market.

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.