Want to know where the market is headed next? Well, the key thing for traders to watch next week is not industrial production data, or the Fed, or jobless claims. No, the most important sign will come from the market itself in the form of volume.

Trading volume always declines in August and continues through the beginning part of September due to Labor Day and Rosh Hashanah. After those holidays, we are supposed to see a return to “normal” trading volume.

Now, “normal” in 2010 is much lower than it was 2007 and 2008. That’s because many individuals have been flushed out of the market, directly or through mutual fund withdrawals, and the explosion in ETFs has also replaced some of volume in stocks. Many hedge funds have also gone bust or are now players in the bond market.

However, if volume does not increase significantly this week, and the week thereafter, the market will likely be setting itself up for a steep and perhaps abrupt decline.

But if volume increases significantly, you may see a pop in the market past the 1,105/1,110 level on the S&P 500.

The key will be Monday’s close. If volume accelerates through the close on Monday, and the market closes on a high, it is probably time to look at call options on the S&P 500. If the market closes on a low, and volume is either light or picks up in the last hour as traders dump stocks, do the opposite and look at some puts on the S&P 500.

2 Ways to Play Europe

With things so uncertain on our own shores, why not look across the pond?

I leave for Europe on Tuesday for some fun, some business, and to drop one of my sons off at college, and my trip is getting cheaper each week as reality sinks in and traders see declines in European economies and currencies.

In my Short Side Trader service, we are playing Europe a couple of ways:

1. Shorting currencies via currency ETFs

You can short the euro with put options on the CurrencyShares Euro Trust (NYSE: FXE), or the pound via puts on the CurrencyShares British Pound Sterling Trust (NYSE: FXB). Or you can go long the U.S. dollar with calls on the PowerShares DB US Dollar Index Bullish (NYSE: UUP), or gold via calls on the SPDR Gold Trust (NYSE: GLD).

2. Shorting the big European banks

Look at puts on banks exposed to lousy sovereign debt such as Deutsche Bank AG (NYSE: DB), HSBC Holdings plc (NYSE: HSC) or Banco Santander, S.A. (NYSE: STD). These stocks all have liquid puts. European banks have even weaker capital bases than U.S. banks, and new standards are coming into effect that will force the banks to raise more capital.

A rumor hit the Street last week that DB was looking at raising a lot of capital with a new stock offering and the stock dropped 2.5% Thursday. A drop like that translates into big gains if you are playing short-term puts.

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