This could end up being a pivotal week for the markets as the general indexes shook off last week's weakness and responded with a strong push higher. While the overall trend is still very much in question, the price action this week introduces the potential for the formation of an important low. Last week the markets failed at an important resistance level and appeared to be headed down to test their July lows. However, the markets only retraced a portion of the prior decline and could be forming an important higher low here. If the markets can climb past their June highs they will be setting a higher high as well.
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The chart for the S&P 500, as represented by the S&P 500 SPDRS (NYSE:SPY) ETF, is illustrating this trend quite clearly. Notice how SPY broke to a new low early in July, threatening a complete breakdown. While it bounced sharply higher from this weakness, many traders expected the inevitable failure once SPY reached its 200-day moving average. SPY did indeed fail near this level, and while it looked like SPY would head back to the July lows, buyers stepped in near its 20-day moving average and SPY ended up clearing its July highs soon thereafter. This is very constructive price action and while SPY remains under its 200-day moving average, the recent strength hints at a possible bottom being formed.
The Diamonds Trust, Series 1 (NYSE:DIA) ETF, which tracks the Dow Jones Industrial Average, tracked a very similar path to SPY, and is showing a little more relative strength. In the process of this week's bounce, DIA was able to climb back above its 200-day moving average and also cleared a trendline touching some recent highs. The more important resistance level to watch is the June high near $106, but this is constructive price action and could signal an end to the downtrend.
The Nasdaq, as represented by the Powershares QQQ ETF (Nasdaq:QQQQ), has been underperforming recently but also managed to reclaim its 200-day moving average and clear its July high. Of course, much like the other indexes, the more important level to watch in the near future is the June high. Clearing this level would mean a higher high, effectively ending the downtrend. This doesn't mean that the markets will suddenly emerge into a new uptrend, but will indicate that the pattern of lower lows and lower highs has been officially broken.
The Russell 2000, as represented by the iShares Russell 2000 Index (NYSE:IWM), also climbed back above its 50- and 200-day moving averages this week. Much like DIA, it also broke out of a channel it had been following and cleared its July highs. If the market picture is truly improving, then leadership should be coming from the small caps and technology stocks.
In last week's column we mentioned that there was a possibility of the markets forming a higher low in this area. This week's price action certainly increases the odds of this scenario. However, for this action to truly mark an end to the correction that began in April, the markets will need to set a higher high and clear their June highs. This would halt the pattern of lower lows and lower highs. While it wouldn't signal an all-clear and a resumption of the preceding uptrend, it would be a sign that the environment is improving. This week's lows are also an important level to watch, as a drop below this level will negate the bullish price action and more than likely predict a drop to new lows.
The markets have done a great job of frustrating participants over the past several weeks, so it's not out of the realm of possibility that they could turn the tables on everyone and break down. But, although this is very similar to the price action we saw in June, this week's price action shouldn't be dismissed, as it does introduce the possibility of an end to the recent correction. The levels to watch are pretty clear and there were some decent have started to appear for individual stocks. Earnings should continue to dominate the news next week and possibly set the tone for the next move.
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