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Tickers in this Article: DIA, QQQ, SPY, IWM, AAPL
After starting the week with a push to new lows that threatened to escalate into a freefall, the stock market roared back from the lows stringing together an impressive rally attempt. From low to high, the S&P500 rallied approximately 10%, although it did back off the highs a little by the Friday close. As impressive as the mid-week strength was, however, it did little to change the underlying bearish trend. The indexes have basically bounced back towards resistance, and the upcoming week should provide a valuable clue as to the next direction the markets take. Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.

In looking at the aforementioned S&P 500 as represented by the S&P 500 SPDRS (NYSE:SPY) ETF, the sharp rebound off of the lows is quite apparent. SPY sliced down below the August lows towards $107 before surging back towards $117 only a few days later. SPY hit resistance near its declining 50-day moving average and remains in a bearish posture (below recent highs). The current trading area was expected to act as resistance, so the fact the SPY is slowing down here is not surprising. The key will be how SPY reacts to this overhead supply in the coming days. If SPY begins to drift lower on light volume, it could set the stage for a true rally attempt and possible bottom. However, if SPY begins to pullback on an increase in volume, it could set the stage for new lows again. (For more, see Trading Failed Breaks.)


The Diamonds Trust, Series 1 (NYSE:DIA) ETF also traded to new lows this week before reversing strongly. It dropped under key support near $105-$106 before rebounding all the way to $112. Much like SPY, the 50-day moving average along with lateral resistance proved to be an area of resistance. The first selling reaction on Friday proved to be rather timid, however, given that it was a gap higher on positive news may install more doubt to market bulls. The best scenario for market bulls would be some sideways consolidation on light volume to work off some of this week's buying pressure without providing any relief to trapped short sellers. This would set the stage for a stronger rally attempt.


After finally caving in to selling pressure the past couple of weeks, the Powershares QQQ ETF (Nasdaq:QQQ) ETF has settled into a similar pattern as its peers. It fell out of a recent channel and headed lower. It did however maintain a little relative strength by not setting new lows. While it may seem semantic, this was a good show of support as buyers were willing to step in ahead of support. Its largest component, Apple, Inc. (Nasdaq:AAPL) at least initially, seems to have absorbed the death of its former CEO and visionary leader, Steve Jobs. While AAPL closed lower, it was not decimated despite disappointing investors with the lack of an iPhone 5 and of course the tragedy that befell Steve Jobs. If QQQ can resume its role as a leader, it may help buoy the markets in the short term.


Every week I mention the relative under performance of the smallcaps and this week is no different. The group as represented by the iShares Russell 2000 Index (NYSE:IWM) ETF plunged to new lows, much like its peers early in the week. IWM then recovered quite nicely in the middle of the week as bulls stepped into the market. However, Friday's bearish engulfing pattern revealed an inherent weakness in the group, especially when each of index ETFs mentioned above closed near the Thursday highs. The $67.50 is now a key level to watch due to the strong negative reaction that occurred on the first test of this level.


The Bottom Line
After closing out last week threatening to enter a crash or freefall scenario, this week's price action had to come as a relief to market bulls. Buyers stepped in at the lows aggressively and staved off the selling at least temporarily. However, the coast is not clear by any stretch of the imagination. The markets simply rebounded from an oversold condition, and traders need to be cognizant of the fact that the markets remain vulnerable. The preceding two months have demonstrated that the markets can change character almost week to week, and traders must not get locked in to any specific outcome. Next week will be very telling, especially if the recent pattern changes. If the markets drift lower next week on lighter volume, I would be more likely to assume a bullish outcome as it would not provide relief for trapped short sellers while relieving some of the recent buying pressure. If the markets head lower on higher volume, I would be more inclined to step aside as the freefall scenario or at least a low retest would likely be back in play. The last scenario is continued higher prices which would pressure short covering, but would also make it difficult to trade while respecting risk. It is definitely a tricky environment, but the market will likely provide much needed clues soon. (For more, see Technical Analysis: Introduction)

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