If Russell Index Loses Support Expect A 3 to 5 Percent Correction In The Broad Market (IWM, TZA, DIA, SPY)

Stocks ended the session lower as trade surged. All five major indices closed in the red with the small-cap Russell 2000 (NYSEArca:IWM) leading the decline. By the closing bell the Russell had shed 1.6% and is now in danger of losing a critical support at 811. The Nasdaq (NASDAQ:QQQ) shed 0.7%, while the S&P MidCap 400 slid 0.6%. Large cap issues fared slightly better as the S&P 500 (NYSEArca:SPY) and the DJIA (NYSEArca:DIA) dropped 0.5% and 0.4% respectively. The precious metal, gold mining, semiconductor and telecommunications sectors took a beating yesterday, while home construction and water utilities showed relative strength.

Market internals were markedly bearish yesterday. Volume spiked by 18.5% on the Nasdaq and 26.7% on the NYSE. Declining volume overpowered advancing volume by a factor of 2.5 to 1 on both exchanges. Yesterday was a definitive distribution day on both the NYSE and the Nasdaq. The high volume suggests that institutional investors were actively selling.

The Russell 2000 Index ($RUT) is in danger of losing support at 811. If the Russell cannot hold support at this mark, the next significant support level is near 785. Tomorrow is an important day for the small-cap index, as it will likely tell us whether or not we will see a more protracted move lower in the broad market. If the Russell holds up, it may just take the market a couple of days to stabilize before moving higher. If the Russell loses support then we wouldn’t be surprised to see a three to five percent correction in the broad market.

If the Russell 2000 fails to hold support, by extension, the Direxion Small Cap Bear 3x Shares ETF (NYSEArca:TZA) would provide a possible buying opportunity. Yesterday, on a big spike in volume, TZA rallied and closed above its 20-day EMA for the first time since December 19, 2011. If this inverse ETF can clear the February 15th high of $19.62, it could provide a short term buying opportunity.

Yesterday was not a good day for Wall Street but it is by no means a reason to become bearish on the market. If the market were to compile 5 or 6 distribution days over a 20-trading day period, then that would be cause for concern. However, in the short run, it is probably best to remain mostly in cash until we get a better feel for how the market will react to yesterday’s sell off. Nonetheless, if quality setups develop, we will continue to trade them accordingly.

The commentary above is an abbreviated version of The Wagner Daily, a daily ETF and stock swing trading newsletter. Subscribers to the full version also receive detailed entry and exit prices for potential swing trade entries, and an additional section dedicated to individual stock trades. To learn more about our trading strategy, please visit our blog.

Deron Wagner is a professional hedge fund manager who founded Morpheus Trading Group, a swing trader education firm, in 2002. He is the author of the best-selling book, Trading ETFs: Gaining An Edge With Technical Analysis. His new book, Advanced Technical Analysis of ETFs, will be released in August 2012. Past television appearances include CNBC, ABC, and Yahoo! FinanceVision. Wagner is also a frequent guest speaker at various trading events around the world, and can be reached by sending e-mail to: [email protected]

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