Thinking of going short? Remember this

Finished with their pre-holiday
shopping, traders returned to the markets in a
bearish mood Tuesday and triggered a broad-based selloff on higher volume.
Stocks began the day with an opening gap up, but the sellers immediately took
control, causing the major indices to trend steadily lower throughout the entire
session. The S&P 500
(
SPX |
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PowerRating), Nasdaq Composite
(
COMP |
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PowerRating), and Dow Jones
Industrials
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PowerRating) each fell 1.0% and also closed at their intraday lows.
Both the small-cap Russell 2000
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RUT |
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showed relative weakness and lost 1.4% and 1.2% respectively. The drop in the
Russell worked out well for our short position in IWM, which is presently
showing a small unrealized profit. IWM short has been our only "official"
position for the past week.

Total volume in the NYSE increased by 21% yesterday, while
volume in the Nasdaq was 13% higher than the previous day’s level. The losses on
higher volume means that both the S&P and Nasdaq registered a bearish
"distribution day" yesterday, but remember that the previous session’s volume
was the lightest day of the year. Despite yesterday’s volume surge, turnover in
both exchanges was still below 50-day average levels. The one factor that didn’t
lie, however, was the session’s ugly market internals. Declining volume in the
NYSE outpaced advancing volume by nearly 4 to 1. In the Nasdaq, the ratio was
negative by nearly 3 to 1. While the "distribution day" surely pointed to
institutional selling, we will probably not get an accurate indication of
traders’ true intentions until average volume levels begin to return after New
Year’s Day. Nevertheless, another "distribution day" this week could really load
up the market with overhead supply going into the new year, especially if volume
rose above average levels in the process.

Nearly every industry sector we follow closed in the red
yesterday. Airlines
(
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exceptions. On the downside, Oil
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OSX |
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PowerRating) sectors
each plummeted by approximately 3%. The selloff caused the $OSX index to break
support of a steep uptrend line that had been in place since mid-October:

As you can see, the 20-day moving average has converged with
prior support of the uptrend line. The convergence point should now act as solid
overhead resistance on any short-term rally attempt. Therefore, advanced traders
may consider shorting OIH, the main ETF that tracks the Oil Service index.
Novice traders, on the other hand, may consider passing on this trade because
stocks and ETFs that break their trendlines near their highs can sometimes be
very tricky. Specifically, they can whip you out of your position by running
your stop, only to reverse and move in the proper direction the next day. Our
long sector watchlist for next month already consists of Gold, Biotech, and
Pharmaceutical, so it makes sense to begin building a watchlist of potential
sectors to short as well. It’s obviously too early to predict the duration of an
Oil correction, but astute traders will want to keep an eye on OIH and other
oil-related shares for potential short entry into the next bounce.

In yesterday’s Wagner Daily, we discussed the bullish
consolidation that has been taking place in the weekly charts of the S&P and
Nasdaq. Although that consolidation is technically still intact, yesterday’s
price action caused some technical damage to the shorter-term daily charts. The
sudden selloff that seemingly appeared out of nowhere is the exact reason we
have been advocating sitting on the sidelines until the holiday season has
passed. Low volume markets can be easily whipped around in an erratic fashion
because they do not take a lot of trading activity in the opposite direction to
spur the volatility.

Looking at the daily chart of the S&P 500 below, notice how
the index closed right at support of its prior low after failing to rally above
the mid-December high:

Although it’s still choppy on the daily chart, we need to be
on the lookout for the formation of a "lower high," followed by a "lower low."
If the S&P breaks support of the 1,249 level (the November 30 low), it would
point to a likely reversal of the intermediate-term uptrend. It would also
signify a failure of the bullish consolidation near the 5-year high, which would
further exacerbate a potential selloff. The other major indices are showing
similar chart patterns of "lower highs" and potential "lower lows" as well. But
before you get excited about shorting SPY or QQQQ, you need to remember the time
of year; it is simply premature to become overly bearish on the broad market
without the proper price and volume confirmation. False breakouts and breakdowns
can be abundant in this type of low-volume environment.

Open ETF positions: