The stock market once again finished the week on a sour note after a promising start. The holiday shortened week began with a significant gap to the downside that threatened a breakdown. However, after the initial weakness on Tuesday, the markets steadily rose higher closing near the highs for the day. While the end result was still a down day, it was a big improvement compared to the open. By Wednesday, the markets gapped higher and had a strong day. This had bulls in a great mood, but much like last week, a mid-week reversal left a bad taste in their mouth. Overall, the markets remain range bound and next week could be a pivotal week for the markets.
In looking at the chart for the S&P500 as represented by the S&P 500 SPDRS (NYSE:SPY), it is clear to see the trading range that has been established over the past few weeks. SPY has been trading in a channel that resembles a bear flag since the early August collapse. The moves within the flag have been volatile, although the overall price action has remained in the lower half of the preceding drop. This is technically bearish behavior, as SPY has been unable to hold on to any gains. Traders will need to keep a close eye on this range, as a move in either direction could escalate quickly.

The Diamonds Trust, Series 1 (NYSE:DIA) ETF is also following a similar channel to SPY. The recent overnight gaps in the index are certainly out of character, and speak to the recent increase in volatility. DIA is currently testing the bottom of the channel, and any breach of this weeks lows next week would likely imply at least a retest of the August lows.

If anything positive can be taken out of this weeks price action, it is the continued relative strength of the Powershares QQQ ETF (Nasdaq:QQQ) ETF. While no one will mistake this weeks price action as strong, QQQ did not approach the early week lows after the upside reversal, and remain well above their August highs. QQQ also managed to close very close to its 20-day moving average. There are still plenty of negative signs here, but still remains in the best shape of the index ETF's.

The smallcaps as represented by the iShares Russell 2000 Index (NYSE:IWM) ETF on the other hand, more closely resemble SPY. IWM is also trading in a channel that is taking the form of a bear flag as it consolidates the early August plunge. These flag patterns are typically consolidation, not reversal patterns, so traders will need to keep a close eye on how IWM acts near the edges of the channel. Of course, the key level to watch would be the August lows. (For more, see Channeling A Path To Success)

Bottom Line
One thing we haven't mentioned yet is how the markets reversed lower this week before reaching the top of the channel. This happened across the board, with only QQQ even coming close. This could be a sign that sellers are becoming more anxious. Next week could be a pivotal one as these ETF's may be pushing to the bottom of these ranges. The markets remain oversold on longer term indicators, but bulls should not be holding out hope simply based on that. The bottom line is that the environment is still quite dangerous and traders should be ready for any scenario, including a second leg down.

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