Trade what you see, not what you think.

Trade what you see, not what you think.

Another capricious session caused stocks to oscillate between positive and negative territory before finishing with mixed results. Both the S&P 500 and Dow Jones Industrial Average lost 0.1%, but the Nasdaq Composite gained 0.2%. The small-cap Russell 2000 also rallied 0.2%, while the S&P Midcap 400 similarly advanced 0.3%. As the nearly unchanged closing prices indicate, the intraday action once again lacked a solid sense of direction, making it challenging for many traders to remain with short-term positions on either side of the market.

Total volume in the NYSE was 9% higher than the previous day's level, while volume in the Nasdaq increased by 13%. Although the Nasdaq rallied on higher volume, it may be deceiving the label yesterday's session as a bullish "accumulation day" because the Nasdaq's gain was primarily due to the exceptional performance of one stock. The announcement of Apple Computer's new iPhone device sent shares of the heavily-weighted stock more than 8% higher yesterday. Conversely, the narrow 0.1% loss in the S&P was not enough to declare the NYSE as having a bearish "distribution day." More accurately, the higher turnover in both exchanges was indicative of "churning" that occurs when volume surges higher, but prices are little changed. This bearish effect results from institutional selling into strength and often precedes a substantial selloff that occurs one or two days later.

If you're a trend trader who has been actively trading the markets over the past week, I'm confident you would agree that profiting from either side of the market has been challenging. Since the new year began, there has been a whole lot of intraday volatility, but little price movement by day's end. The S&P 500, for example, has whipped around in a 1.8% range over the past five days, but is only showing a price movement of 0.4% (lower) since the start of January. This erratic action has resulted in many traders getting stopped out of both long and short positions, only to see their stocks and ETFs reverse in the proper direction a few hours later. The directionless trading is made apparent on the daily chart of the S&P 500. Looking at the chart below, notice all the "wicks" or "tails" on the candlesticks of the past five days:

As you can see, the S&P 500 has experienced quite a bit of intraday volatility, but has made little headway in either direction since the new year began, especially within the last three days. The same could be said of the other major indices as well. Check out the tight, sideways range in the Nasdaq Composite:

The longer such a tight and narrow range continues, the more significant the eventual range expansion will be. A quick glance at both charts above illustrates the close proximity of both the S&P and Nasdaq to support of their 50-day moving averages. The 50-day MA on the S&P is currently at the 1,401 level, while the Nasdaq's 50-day MA is at 2,417. Also, notice how the two-day low in the S&P and three-day low in the Nasdaq coincides with support of their respective 50-day MAs. This convergence makes the 50-day MAs all the more important. Don't forget that both the market-leading Russell 2000 and S&P Midcap 400 indices have already broken their 50-day MAs.

We expect both the S&P and Nasdaq to make substantial, momentum-driven moves over the next several days. A break of their 50-day MAs (which converge with their January lows) would probably result in a rapid downward thrust. On the other hand, an intraday probe below the 50-day MAs could just as easily trigger a wave of institutional buying. Because of these indices sitting at "make it or break it" levels, we continue to recommend caution and reduced share size with all new positions. Now that earnings season is underway, the reaction to the numerous corporate report cards will be the driving factor that determines which direction the broad market goes. Be careful out there and remember to always trade what you see, not what you think!