The market has produced some clear warning signs over the past week, with stalling action and distribution in the major averages, along with the S&P 500 and Nasdaq Composite closing below the 20-day EMA.

Our stock trading system is heavily focused in small and mid-cap growth stocks. With the small cap Russell 2000 breaking down below the 50 and 200-day MAs, and the S&P 400 at the 50-day MA, there is cause for concern. That being said, these indices have already pulled in quite a bit and may be due for a reversal within the next few days.

Many well-known growth names have performed poorly vs the S&P 500 over the past several weeks. For example, Tesla Motors ($TSLA) and Facebook ($FB) have basically chopped around for several weeks heading into earnings. Other growth-type stocks that are not as well known like Palo Alto Networks ($PANW) and Cavium ($CAVM) have failed recent breakouts to new highs.

The rally in the Nasdaq was fueled by the strength in semiconductor stocks breaking out to new highs and in biotech stocks recovering from an ugly sell off. However, it looks as if the run in semis may be over for a few weeks, as Thursday's bearish candle in Semiconductor ETF ($SMH) closed below the 10-day MA on heavy volume. $SMH will probably need a few weeks of consolidation at the very least to digest last the rally.



After a sharp 7-week rally above the 50-day MA, Biotech ETF ($IBB) has given back almost 10% the past two weeks, and could be headed to the 200-day MA if the 50-day MA does not hold.

With money rotating out of biotechs and semiconductors, what industry group will now step to the plate? As for yesterday's price action, there were virtually no signs of strength, with the exception of mining stocks (gold and silver).

Given this week's warning signs, we are tightening up stops in a few positions and cutting back size in others. The idea is that something must be done when conditions are no longer ideal.

Although the market rally is in trouble, there isn't enough evidence out there to shift the timing model into sell mode. Still, we have been cautious the past two weeks in adding new names, as the short-term plan has been to lay low and for the most part we have done that as of late.

As for the broad based averages, it is possible that the market is entering chop mode, where there may be a day of heavy selling with a close near the lows of a range (like the S&P 500 on Thursday), that is followed by a 2 or 3 day bounce back to the highs of the range. We could potentially see the market chop around until there is a catalyst from earnings season, which heats up in late July and early August.

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.