In the May 9th, 14th, 17th and 30th editions of The Wagner Daily stock newsletter, we pointed out and analyzed the bearish "head and shoulders" pattern that was forming/had formed on the small-cap iShares Russell 2000 Index ETF ($IWM). In the May 9th newsletter we stated, "if the Russell 2000 loses support of the neckline at 785, the predicted selloff would be to 720. We will be monitoring the Russell carefully, as its next test of the 785 mark could result in the loss of support and a significant move lower". On May 14th we commented that, "(a move by IWM) below Friday's low of $78.42 could result in a break of the neckline of the head and shoulders pattern. A drop below this key market would likely result in a quick move to the 200-day MA for IWM. On May 17th we stated that, "IWM did in fact breach its neckline and now appears headed for the 200-day MA. In all likelihood, IWM will find support at its 200-day MA. Typically, when the neckline of a "head and shoulders" pattern is broken, a subsequent bounceback up into resistance near the neckline will follow. This bounce generally results in another shorting opportunity." To refresh your mind, below is a chart of IWM from our May 17th newsletter:



The current chart of IWM (based on the June 1 close) shows the ETF is now within 2 points (less than 3%) of our originally predicted downside target for the head and shoulders pattern. Now that IWM has plunged below its nine-day low, this target may be reached quickly.



In addition to discussing the predicted downside price target of $IWM, we also recently stated (in our May 30 newsletter) that the S&P 500 SPDR ($SPY) and PowerShares Nasdaq 100 ETF ($QQQ) would likely need to "undercut" support of their respective 200-day moving averages before a reversal of the current intermediate-term downtrend is likely to occur in either ETF. Typically, in order for the market to reverse from a significant downtrend, a massive "shakeout" move is needed to both eliminate any remaining market bulls and to get a disproportionate number of bears into the market. Only then do reversals typically occur. On June 1, SPY indeed closed below support of its 200-day MA, while QQQ closed just above its 200-day MA. The stage is now set for a significant "shakeout" move below this key mark on both ETFs, at which point SPY and QQQ may become positioned for a substanial reversal.





Due to the bullish price action of May 31 (last Thursday), we covered our position in S&P Consumer Discretionary SPDR ($XLY) at the open, locking in a small gain. We are now seeing the first signs of capitulation in the market, as last Friday showed the worst point loss of the year for the broad market. We are not looking to enter new short positions at this juncture because the reward to risk ratio is no longer in our favor. This is not the time to chase the market lower. Last Friday's downward move was difficult to participate in because, on a technical level, the main stock market indexes all formed bullish intraday reversal bars on Thursday, AND on sharply higher volume. This led technical traders to believe the next near-term move would be to the upside. So, when the market gapped substantially lower on the following day's (June 1) open, the bulls who bought on Thursday were trapped in their positions, which further compounded the weakness 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.