In the November 2 issue of our trading newsletter, we concluded our ETF trading commentary by saying, "Given the kind of weakness that we've seen lately, including continued relative weakness in key large-cap tech stocks like Apple ($AAPL), it would not be surprising if there is minimal upside follow-through on yesterday's bounce." Indeed, not only was there a lack of follow through to the upside, but stocks also gave back a majority of the previous day's gains. After falling an average of more than 1%, all the main stock market indexes closed at their dead lows of the day, and in the bottom half of their trading ranges for the week.

Although stocks managed to retain a small portion of their November 1 gains, the technical situation created by last Friday's decline puts the stock market in a rather precarious position. Specifically, each of the major indices formed a bearish engulfing candlestick pattern, which forms when an index or stock opens above the previous day's high, but sells off to close all the way below the previous day's low. This pattern can be clearly seen on the daily chart of PowerShares QQQ Trust ($QQQ), a popular ETF proxy for trading the Nasdaq 100 Index:



As you may recall from this recent article on our trading blog, we prefer to sell short stocks and ETFs only after they've broken down below an obvious level of technical price support, then subsequently bounce into a resistance level and form a bearish reversal pattern. One such ETF we came across in our nightly stock scanning that meets the criteria is iShares Dow Jones US Real Estate Index ETF ($IYR). We have annotated this ETF swing trade setup on the daily chart of IYR below:



After bouncing off major support of its 200-day moving average on October 26, IYR moved back above near-term resistance of its 20-day exponential moving average on November 2. However, notice that it formed a bearish reversal candle that same day by rallying substantially higher from its opening price, but reversing to close back down near its open. Furthermore, more substantial intermediate-term resistance of its 50-day moving average is now just above the intraday high of November 2. Additionally, the 20-day exponential moving average formed a bearish pattern by crossing down below its 50-day moving average several weeks ago. All these factors provide us with an ideal entry point for short sale entry into IYR going into today's session. Regular subscribers of our Wagner Daily swing trade newsletter should note our preset trigger, stop, and target prices for this setup in the ETF Watchlist of today's report.

Because many of our subscribers trade in non-marginable cash accounts, such as IRA accounts, we are not "officially" planning to sell short IYR. Rather, we are looking for a buy entry into ProShares UltraShort Real Estate ETF ($SRS), an inversely correlated "short ETF," instead. If you turn the chart of IYR upside down, the chart pattern of SRS is nearly (but not exactly) the same. The pattern is slightly different because inversely correlated and leveraged ETFs sometimes underperform the actual underlying index over longer holding periods. However, since we're stalking this as a short-term, momentum-based trade, the degree of underperformance is not likely to be significant. Traders with marginable accounts who can sell short may wish to use our buy signal into SRS as a signal to sell short IYR instead, but our "official" trade setup is to buy SRS if it trades through our exact trigger price for buy entry.

As we've mentioned several times over the past two weeks, we've been monitoring both PowerShares QQQ Trust ($QQQ) and iShares Nasdaq Biotechnology Index ($IBB) for potential short sale entries on a significant rally into resistance. However, last Friday's major weakness already sent QQQ right back down to near its recent lows, while IBB has been so weak that it actually closed the week at a new "swing low." As such, there simply is not a positive reward-risk ratio for selling short either of these ETFs at this time. Nevertheless, since these two ETFs have been showing such considerable relative weakness to the broad market, they remain on our internal watchlist for when they inevitably and eventually muster up the momentum for a significant short-term bounce into resistance. As for the long side of the market, select Emerging Markets ETFs continue to hold up well and show decent relative strength. But as the November 2 price action demonstrated, the broad market simply remains much too weak to attempt any bullish entries right now because current breakout attempts, even in stocks and ETFs with relative strength, have a high likelihood of failure. This is typical price action when our stock market timing model is in "sell" mode.

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.