The NASDAQ Composite continues to struggle with Tuesday's selling on higher volume, which produced a bearish distribution day. The fact that Tuesday's 0.3% loss produced more volume than Tuesday's 1.8% advance is a troubling sign for the bulls because it indicates "churning" (stealth institutional selling into strength):



The S&P 500 basically closed flat, but in the lower third of the day's range with some mild stalling action on lighter volume. Had the S&P closed at the lows of the day on higher volume after a 1.0% advance in the morning, then the stalling action would have been churning:

The NASDAQ 100 (and $QQQ) held above the 50-day moving average for the second day in a row, but has lacked conviction in doing so. A big key to the action in $QQQ will be how the recent gap up in $AAPL plays out.

Although the S&P 500 has set a new high this week, the price action "under the hood" in most sectors has not been convincing. An example of this is the recent light volume breakout to new highs in the transportation sector, as represented by iShares Transportation ETF ($IYT):



$IYT printed a wide-ranged breakout candle on Monday, but volume was both lighter than average and the prior day's level (which was a much smaller-ranged candle). $IYT's volume on Tuesday's small ranged day was actually bigger than Monday's strong advance as well.

Whenever there is a wide-ranged "up" candle, volume should also come in heavier than average. When this doesn't happen, it is a sign that something is wrong.

After a strong advance over the past few months, Consumer Staples ETF ($XLP) set a new high on a continuation breakout with the lightest volume it has seen since February. That session was followed by a heavier volume stalling candle on Monday:



Our market timing model remains in neutral, with a bias to sell mode, due to the lack of conviction in the current rally. Only the S&P 500 and Dow have made new highs, while the other major averages continue to struggle.

With leadership from utilities, staples, REITS, and energy, the S&P 500 has stayed relatively strong vs. the Nasdaq, but these groups do not typically lead when times are good.

On the stock side, we continue to play it VERY conservatively, as the reward to risk ratios on the long side are no longer in our favor. What this simply means is that there is little reward for the increased risk we take going long.

We are nearing the "needle in a haystack" type of market, which occurs when conditions are no longer ideal and fewer stocks are making explosive moves. However, there will always be a stock that bucks the trend and rips higher despite weak conditions, and this stock is usually very easy to spot after the fact, as it is the only one up a ton.

During a bull market rally, our stats indicate that anywhere from 100 to 150 stocks can advance 20-30% over a four-week period. However, when conditions begin to sour, that number will drop off considerably, as fewer stocks are breaking out from quality buy patterns.

Trying to find the big winner in a bad market is the needle in a haystack trade. Like we mentioned above, we are not in that type of market yet, but could be very soon.

Overall, being mostly in cash (SOH mode) or in a few longs that are not heavily correlated to the S&P 500 seems to be the best bet right now. Even the short side is not a slam dunk, as there is still some fight left in stocks and ETFs that have recently broken down.

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.