Stocks surged higher on Friday helping the Nasdaq post its biggest weekly gain since the initial rally off the March 2009 lows. However, as has been common lately, the rally was accompanied by light trade. All five major indices closed in the black as higher beta issues led the advance. By the closing bell both the S&P MidCap 400 and the small-cap Russell 2000 had added 2.0% while the Nasdaq tacked on 1.8%. The S&P 500 climbed 1.7%. The Dow Jones Industrial Average was the day's laggard but the blue chip index still gained an impressive 1.5%.

Market internals ended the session mixed for the sixth time in eight sessions. Volume fell marginally on the Nasdaq but was down a healthy 9.0% on the NYSE. Advancing volume outperformed declining volume by a factor of 7.4 to 1 on the NYSDE and 3.0 to 1 on the Nasdaq. Despite the outstanding price action in the market over the past week, it is difficult to jump on the bullish bandwagon given the light volume throughout this nine-day rally.

Two weeks ago we stated that the market may reverse if we see a sharp undercut of support at 1,100 on the S&P 500. Since then the market has rallied eight of the past nine sessions. An indicator that we sometimes use to assist us in our market timing is the Accumulation/Distribution Indicator (by price and volume). This indicator is considered a rough leading indicator to market reversals when it diverges significantly for several weeks to several months from price action. As a rule of thumb we like to see at least two divergences over a 4 to 8-week timeframe before we will begin to monitor it more closely. The chart below of the iPath S&P 500 VIX Short-Term ETF (VXX) provides an excellent example of this divergence between price and the Accumulation/Distribution technical indicator. Notice how the VXX set a higher high twice as Accumulation/Distribution failed to confirm. What's most important is the slope of the line and not the absolute value. The Accum./Dist. Indicator remained flat as VXX was setting higher highs. This was a bearish divergence that clearly warranted our attention. However, also notice that the Accum./Dist. Line is still in an uptrend and did not set a lower low with the price action in VXX on Friday. The fact that the Accum/Dist Line for VXX is still in an uptrend and did not set a lower-low with the price action on Friday suggests that caution is warranted on the long side of the stock market. The point is simple; it may be a bit too early to call off the bear market.

Although we had legitimate entries in both SRS and DTO the bullish surge in the market knocked us out of both trades on Friday as our stops were triggered. Our overnight research revealed very few long or short setups and we are satisfied to be in cash until the market provides a clear signal as to its next move. Although we expect a pullback in the market over the next several days, we still expect more upside over the next 2 to 4 weeks.



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.