Stocks fell sharply on Monday on mixed trade. The day ended with the DJIA, S&P 500 and Nasdaq all closing below their respective 200-day moving averages. Smaller cap issues led the decline as the S&P MidCap 400 and the small-cap Russell 2000 plunged 2.5% and 2.6% respectively. The S&P 500 also dropped 2.5% while the Dow Jones Industrial Average fell 2.3%. The Nasdaq put in the day's best performance but still fell 1.9%.

Market internals were mixed on the Nasdq but bearish on the NYSE. Volume increased by 4.2% on the NYSE but fell on the Nasdaq by 1.9%. However, declining volume topped advancing volume across the board. By the closing bell the spread ratio stood at a negative 15.1 to 1 on the NYSE and minus 6.1 to 1 on the Nasdaq. We would classify Monday as a distribution day for the NYSE due to the higher volume and significantly higher ratio of declining volume. What is concerning about yesterday's action is that it represents the second distribution day on the NYSE since this rally began in early October.

Yesterday, on increasing volume, the iShares US Real Estate Index ETF (IYR) formed a reversal candle as it overcut its 200-day MA. A move below the two-day low of $56.93 could provide a shorting opportunity in this ETF. We will be monitoring this setup closely for a potential short entry.



The SPDR S&P Retail ETF (XRT) sold off on declining volume yesterday as it broke support of the two-day low. Further retracement into support of the 20-day and 200-day moving averages could provide a buying opportunity in this ETF.



In yesterday's newsletter we stated, "we are of the opinion that the market may be approaching an overbought level. We also believe caution is now warranted on the long side of the market for the short run". Those words proved to be accurate as the market tumbled sharply on the day. There's nothing unhealthy about a market pullback but it's never good when the market sells off on increasing volume. We generally don't like to see more than four distribution days in a month and we now have two in the past five days on the NYSE and the S&P 500. If we have a follow-through day to the downside on Tuesday then we'll have to begin to seriously consider the possibility that the recent rally was nothing more than a bear market retracement. Time will tell.

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.