Stocks gapped down sharply at the open yesterday but rallied steadily throughout the day to close near session highs. Still, for a third consecutive day all five major indices lost ground. The Dow Jones Industrial Average fell 0.9% while the S&P 500 lost 0.7%. The S&P MidCap 400 shed 0.6% as the small-cap Russell 2000 and the Nasdaq shed 0.4% and 0.3% respectively.

Market internals ended the session bearish. Turnover increased by 10.7% on the Nasdaq and 17.9% on the NYSE. Further, declining volume held the upper hand on both major indices. On the NYSE declining volume outpaced advancing volume by a ratio of 3.7 to 1 and on the Nasdaq by a factor of 2.0 to 1. Despite the bearish internals we are not inclined to classify Tuesday as a distribution day since price action resulted in the formation of a reversal candle on both the Nasdaq and the NYSE.

On September 1 the ProShare UltraShort Euro ETF (EUO) broke above its downtrend line that had been in place since June of 2010. Yesterday, on a massive burst in volume EUO formed a breakaway gap, and established a higher high (compared to August 8 high). If EUO can put in place a higher low on its next pullback, we are likely witnessing a trend reversal in this ETF. We will be monitoring EUO closely for a potential long entry.



The iShares MSCI EAFE Index ETF (EFA) has been showing relative weakness to the broad market. Over the past two weeks as the S&P 500 rallied above its August 17 high, EFA was unable to set a new high. Further, EFA undercut support of its August 8th swing low yesterday as the market reversed well above this key mark. This divergence between the broad market and EFA suggests that the next test of yesterday's low could result in significant selling in this ETF. We are monitoring EFA for a possible short entry.



The market actually showed signs of resiliency given the breadth of the morning gap down yesterday. Nonetheless, market volatility doesn't tend to bode well for bulls. Further, there continues to be an absence of market leadership and until this situation is corrected we will continue to pursue opportunities on the short side of 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.