Volatility increased slightly last week and looks like it is returning to normal levels. For short-term traders volatility creates opportunities. We seem to be in a short-term pullback within a long-term uptrend, so there is an opportunity to profit on the short side while waiting for a chance to add to long stock positions.

Stocks pulling back after large gain
Broad stock market averages closed lower for the second week in a row. SPDR S&P 500 (NYSE: SPY) fell by 1.3%. The S&P 500 index is now about 2.25% below its recent high.

PowerShares QQQ (Nasdaq: QQQ), an ETF that tracks the 100 largest Nasdaq stocks, lost 2.25% last week, and the index is sitting 2.86% below its recent high. From this level, it is too soon to call for a market top, although a pullback does seem likely.

In the most recent up move, QQQ gained 17.55% from its June low. Long-term returns in the stock market average 7%-10% a year, so after a gain of the magnitude we saw in less than four months, traders should expect to see at least a brief consolidation or a pullback in price. Fibonacci levels are useful to identify where short declines should end.

A pullback to the first Fibonacci level at $66.55 would retrace 38.2% of the prior up move and would be considered normal in a bull market. A 50% retracement is still considered to be normal within a bullish trend. If the price of QQQ breaks below the lower line in the chart at $64.07, traders should switch to a bearish outlook. Until a close below that price, QQQ is still considered to be in an uptrend.

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Our position in QQQ was stopped out at $68.60 last week, which was the breakeven level for the trade. Now, it is time to look for the next entry. This current pullback probably has more to go on the downside. But the potential for a short trade is rather limited if this down move is a pullback and not the start of a deeper decline.

For now, it seems like the most conservative traders should stay on the sidelines. Aggressive traders should consider buying ProShares UltraShort QQQ (NYSE: QID), an ETF that goes up when the Nasdaq 100 goes down. The stochastics buy signal shown in the chart below has been consistently accurate 67% of the time during the past 15 years.

Action to Take --> Buy QID at a limit price of $28. Set stop-loss at $26.60. Set initial price target at $30.10 for a 7.5%-plus gain.

Gold in a consolidation
SPDR Gold Trust (NYSE: GLD) was almost unchanged for the second week in a row. In the daily chart, we can see that gold has been consolidating during the past two weeks.