In yesterday's newsletter, we took an updated look at anticipated support and resistance levels of several of the broad-based ETFs. We then concluded our technical commentary by saying,"Now that the switch to an overall bearish sentiment has been confirmed, we are now patiently waiting for an eventual bounce in the broad market that will provide us with ideal, low-risk entry points on new short positions or inversely correlated 'short' ETFs." This means our focus is now primarily on the short side of the market, as even ETFs with a low correlation to the direction of the stock market have started feeling the pinch of the overly bearish sentiment in the equities markets. However, patience to wait for the proper entry points is crucial because the ETFs with relative weakness that are on our radar screen as potential short sale candidates remain glued to their lows.

Because fear is a more powerful human emotion than greed, stocks and ETFs nearly always fall much faster and more violently than they rise. As such, there are key technical differences in our trading strategy with regard to the price levels where we look to sell short, compared to the ways in which we buy stocks and ETFs.

Presently, the vast majority of ETFs we are monitoring for potential short sale entry (or buy entry for inversely correlated "short ETFs") have either set new "swing lows" within the past few days, or are trading too close to a prior low, to initiate a low-risk entry point at current levels. We do not sell short ETFs that are breaking down below obvious levels of support, as they tend to rebound and rip higher after just one to two days of weakness.

Our most ideal short selling candidates are ETFs that have recently set new "swing lows" (or are testing prior lows), and have subsequently bounced into resistance over a period of three to ten days. Right now, we are developing an internal watchlist of ETFs that may do so in the coming days. One such candidate is PowerShares QQQ Trust ($QQQ), which will likely bounce off major support of its 200-day moving average within the next day or two, but then stall when it encounters moving average resistance, as well as resistance of its new downtrending channel. This is shown on the daily chart of QQQ below:



Although we prefer to wait for a bounce off the lows before entering new short positions, it is important to realize we do not enter a new short sale while the ETF is still bouncing (trying to catch the high of the bounce). Rather, we first wait for subsequent confirmation that the ETF is about to stall again. This typically comes in the form of either a bearish reversal bar (such as a bearish engulfing or hanging man candlestick pattern) or sharp opening gap down, which signals the short-term bounce is losing steam. Similarly, we take the same approach on the long side when buying pullbacks of uptrending stocks; we always wait for a pullback to form some sort of reversal pattern before buying (rather than trying to catch the bottom of the pullback).

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.