Stocks got off to an encouraging start yesterday, as the Nasdaq and S&P 500 indices gapped to open above the highs of their week-long consolidation patterns. However, in an opposite pattern of the preceding two days, the broad market reveresed in the afternoon, causing the main stock market indexes to fade to new intraday lows and settle back in the confines of their previous trading ranges. Both the S&P 500 and Dow Jones Industrial Average finished unchanged. The Nasdaq Composite surrendered an earlier gain of 0.4% to close 0.2% lower. The S&P MidCap 400 and small-cap Russell 2000 indexes slipped 0.2% and 0.3% respectively.

On the surface, the actual closing prices of the major indices were not that bad. However, a closer look "under the hood" reveals a more bearish picture. In both the NYSE and Nasdaq, total volume jumped approximately 17% above the previous day's levels. Further, declining volume exceeded advancing volume by just over 3 to 2 in the Nasdaq. The NYSE adv/dec volume ratio was marginally negative. Overall, yesterday's higher turnover across the board hinted at stealth institutional selling into strength. Yesterday also marked the first "distribution day" (higher volume decline) on the Nasdaq since August 2nd. The NYSE escaped the same label of distribution because it was flat on the day. Although it's negative for the Nasdaq to print a "distribution day" on its first breakout attempt above its recent trading range, it typically takes at least 3 or 4 such days of higher volume selling to convincingly kill an uptrend in the market.

Despite the distribution in the Nasdaq Composite Index, it is positive to note that the large-cap bretheren of that tech-heavy index, the Nasdaq 100 Index, still managed to close above the prior resistance (new support) of its consolidation pattern. This is shown below on the 60-minute (hourly) chart of PowerShares QQQ Trust ($QQQ), a popular ETF proxy for the Nasdaq 100 Index:



Going into today's session, keep a close eye on whether or not $QQQ manages to hold support of yesterday's intraday low. If it does, we could see another rally attempt to push stocks back above their consolidation patterns. However, if $QQQ falls below yesterday's low, we would not be surprised to see a swift return back down to test the lows of the recent sideways trading ranges. Also, the stock market still needs to see at least a bit of relative strength in the small and mid-cap growth indexes in order to have a powerful follow-through rally. Therefore, you may wish to monitor the day to day price action of both $IWM (iShares small-cap Russell 2000 Index) and $MDY (S&P Midcap SPDR).

Although yesterday resulted in a bearish "distribution day" on the Nasdaq Composite, volume still limped in below its 50-day average level, so it was not a massive wave of selling. Further, the NYSE did not confirm the move. Overall, stocks still appear positioned for a move higher, but as we discussed in yesterday's newsletter, volume needs to pick up on the buy side if we are to see a sustainable move higher. The "neutral" mode of our market timing model indeed remains the correct bias at the present time.

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.