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Healthy consolidation in U.S. Dollar Bull Index (UUP) – June 2, 2010

|Includes: GDX, SPY, PowerShares DB USD Bull ETF (UUP)

Stocks kicked off the month of June with another dose of high volatility, as early gains swiftly dissolved into substantial losses in the final hour of trading. The Nasdaq Composite, up 0.9% at its morning high, limped to the closing bell with a 1.5% loss. The Dow Jones Industrial Average and S&P 500 traded in a similar pattern before finishing lower by 1.1% and 1.7% respectively. Small and mid-cap stocks suffered the worst declines. The Russell 2000 plunged 3.1%, as the S&P Midcap 400 tumbled 2.6%. All the main stock market indexes closed at their dead lows of the day, and just above their lowest closing prices of May.

Despite last Friday's session preceding a holiday weekend, yesterday's turnover was even lighter. Total volume in the NYSE was 2% lower than the previous day's level, while volume in the Nasdaq eased 4%. Volume in both exchanges also remained below 50-day average levels. Since yesterday was the fourth consecutive session of slower trade in the NYSE, it will be important to see which direction the market moves when volume comes back into the market. A solid session of higher volume gains would be a positive start, but clear signs of institutional buying have been absent since the broad market began its correction early last month.

Persistent weakness in the euro helped the U.S. Dollar Bull Index (NYSEARCA:UUP) to trend steadily higher throughout the first half of May. Since then, over the past two weeks, UUP has been consolidating in a sideways range, near its recent highs. This "correction by time" is healthy because it enables UUP to build a base of support, from which to subsequently make another leg higher. It also allows the various moving averages to catch up to the price of UUP, thereby providing support as well. Take a look:

UUP

The dotted horizontal line on the chart above marks the low of the two-week consolidation, a short-term area of support. Notice how the 20-day exponential moving average (the teal line) roughly converges with that price as well. Rather than buying UUP on a breakout above the high of its current consolidation, we would prefer to enter UUP on a pullback that "undercuts" the short-term area of support shown above. Buying a dip below an obvious level of support provides lower risk entry points in the current environment, which translates into a more positive reward-risk ratio for the trade. Therefore, we're stalking UUP for potential buy entry on an "undercut" of its current consolidation.

In yesterday's commentary, we annotated and discussed the short setup that was developing in Market Vectors Gold Miners (NYSEARCA:GDX). When the market opened yesterday, GDX initially rallied higher, but reversed sharply lower after running into horizontal price resistance on its daily chart. This trapped the bulls who bought the rally above the three-day highs, and caused a bearish "shooting star" candlestick pattern to form. In the coming days, we anticipate a move back down to its 200-day moving average and May low:

GDX

One week ago, the S&P 500 bounced sharply off key support of its February 2010 low, but the index headed back down after bumping into overhead resistance of its 200-day moving average. Now, it appears the February lows may soon be tested again. The daily chart of the S&P 500 Index is shown below:

SPX

Obviously, a break below the February/May lows (the dashed horizontal line) would be quite bearish, and would probably cause the major indices to make another leg down within the current downtrend. However, an equally likely near-term scenario may be for stocks to hold their recent lows, and attempt to muster up the strength to break above last week's highs. The more negative market sentiment becomes this week, the more likely stocks will bounce again, even if only for a few days. Still, because intraday and overnight volatility remains quite high, with no convincing signs of price stabilization in the broad market, our market timing model continues to suggest remaining in a passive, capital preservation mode. Remember that patient and disciplined traders are always rewarded in the long-term. Moreover, be sure to trade what you see, not what you think.

Open ETF positions:

Long - UNG
Short (including inversely correlated "short ETFs") - GDX
The commentary above is an abbreviated version of a daily ETF trading newsletter, The Wagner Daily. Regular subscribers receive daily updates on all open positions, as well as new ETF trade setups with detailed trigger, stop, and target prices. Intraday Trade Alerts are also sent via e-mail and/or text message, on as-needed basis. For your free 1-month trial to the full version of The Wagner Daily, or to learn about our other services, please visit morpheustrading.com.

Deron Wagner is the Founder and Head Portfolio Manager of Morpheus Trading Group, a capital management and trader education firm launched in 2001. Wagner is the author of the best-selling book, Trading ETFs: Gaining An Edge With Technical Analysis (Bloomberg Press, August 2008), and also appears in the popular DVD video, Sector Trading Strategies (Marketplace Books, June 2002). He is also co-author of both The Long-Term Day Trader (Career Press, April 2000) and The After-Hours Trader (McGraw Hill, August 2000). Past television appearances include CNBC, ABC, and Yahoo! FinanceVision. Wagner is a frequent guest speaker at various trading and financial conferences around the world, and can be reached by sending e-mail to deron@morpheustrading.com.



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Disclosure: Long UNG, Short GDX