A morning gap down pulled stocks lower for a third consecutive day. All of the major indices ended the session down by at least one percent. Smaller cap issues continued showing relative weakness as the small-cap Russell 2000 and the S&P MidCap 400 fell 1.8% and 1.3% respectively. The S&P 500 and the Nasdaq both slid 1.1%, while the Dow Jones Industrial Average lost 1.0%.

Market internals were mixed on Monday. Volume dropped on the Nasdaq by 13.0% and on the NYSE by 4.0%. However, declining volume outpaced advancing volume on both exchanges. By the close, the ratio of declining volume to advancing volume stood at 9 to 1 on the NYSE and 4.9 to 1 on the Nasdaq. Although Monday's price action was quite negative, the decline occurred on light volume, suggesting institutions were not participating in the selling.

Yesterday, on a pop in volume, the inversely correlated ProShares UltraShort Basic Materials ETF (SMN) rallied through key resistance and closed in the upper third of its intraday range. If market conditions remain weak, SMN could offer a buying opportunity, but only if it pulls back and holds support near the recent breakout. Gap ups make it difficult to enter trades, as they skew the reward to risk ratio.



Although we are not yet primarily bearish on the market, our market timing model has flashed a sell signal. As a result, we intend on keeping any open positions on a short leash. Further, unless something dramatic occurs, we are also inclined to be very selective with respect to entering new trades. Risk management is our utmost concern under the current market conditions.

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.