The stock market continued its hot streak, vaulting higher for the third straight week of 2012 and the fourth straight week dating through last year. The recent rally has carried many of the index ETFs past significant resistance levels and could bode well for the early part of 2012. However, the market is already overbought and could be vulnerable to a pullback soon. There are some individual equities that are starting to experience selling, which could signal that market participants are getting more aggressive in protecting gains. Google, Inc. (Nasdaq:GOOG), for instance, sold off over 50 points on Friday following a disappointing earnings report.

Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.

The S&P 500, as represented by the S&P 500 SPDRS (NYSE:SPY) ETF, had a very solid follow-through week as it extended itself from its October highs. SPY is starting to get in position to challenge its 52-week highs, although a breakout is highly unlikely without some consolidation. The longer-term picture certainly improved this week, but SPY is very vulnerable to a pullback right now. The market followed a similar pattern for much of last year, where it would slowly drift higher before a sudden correction. While there could certainly be more near-term upside, traders should really be on guard at this point. The $128 area would be a likely area for support moving forward, unless a violent pullback occurs. In that case, the $125 level may attract buyers. (For related reading on ETFs, see 6 Popular ETF Types For Your Portfolio.)



The DJ Industrial Average, as represented by the Diamonds Trust, Series 1 (NYSE:DIA) ETF, had a very strong week as well. It closed at its highs for the week on the heels of solid earnings reports from some of its components. DIA is also in a position to test its 52-week highs near $128, and in fact, it is almost there. At this point, that level may act as a magnet as participants begin to expect the test. However, much like SPY, it would be dangerous to assume a breakout without some consolidation or pullback. It is very difficult for a breakout to succeed when there are so many market participants sitting on profits. Typically, investors will flee on the first sign of weakness in order to protect quick gains. The $122 level remains a key area to watch on any weakness. (For related reading, see 3 Reasons Not To Trade Range Breakouts.)



The Bottom Line
While the markets have made some clear progress so far in 2012, they are starting to get very vulnerable to a pullback. The markets are overbought on many measures and many individual stocks are extended. Chasing breakouts is rarely a successful strategy and this market has punished this behavior consistently over the past several months. However, the recent strength may be leading to a character change in the markets and if the markets can consolidate in a healthy manner, it may set the stage for more upside in the coming months. All the index ETFs have now set higher highs and higher lows, so until this pattern reverses, it can be assumed that healthy pullbacks will be buyable. (For related reading, see ETFs Vs. Index Funds: Quantifying The Differences.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Charts courtesy of stockcharts.com

Related Articles
  1. Trading Strategies

    How To Buy Penny Stocks (While Avoiding Scammers)

    Penny stocks are risky business. If want to trade in them, here's how to preserve your trading capital and even score the occasional winner.
  2. Mutual Funds & ETFs

    ETF Analysis: Vanguard Total World Stock

    Learn about the Vanguard Total World Stock exchange-traded fund, which invests in stocks located in numerous countries with a high level of diversification.
  3. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  4. Mutual Funds & ETFs

    ETF Analysis: BioShares Biotechnology Products

    Learn more about the BioShares Biotechnology Products fund, an exchange-traded fund that is focused on producers of FDA-approved drugs.
  5. Mutual Funds & ETFs

    ETF Analysis: SPDR EURO STOXX 50

    Learn about FEZ, the Euro Stoxx 50 ETF. FEZ tracks the 50 largest companies in Europe, making it the Dow Jones Industrial Average of Europe.
  6. Mutual Funds & ETFs

    ETF Analysis: ProShares UltraShort Nasdaq Biotech

    Learn more about an innovative inverse-leveraged sector exchange-traded fund, or ETF, the ProShares UltraShort Nasdaq Biotechnology fund.
  7. Chart Advisor

    Value Stocks Offer Stability in a Volatile Market

    With volatility on the rise, investors are turning to segments of strength such as value stocks. We'll take a look at several ETFs that could be worth a closer look.
  8. Mutual Funds & ETFs

    ETF Analysis: Market Vectors EM High Yield Bd

    Learn more about the Market Vectors Emerging Markets High Yield Bond ETF, a fund dedicated to subinvestment grade foreign debt issues.
  9. Mutual Funds & ETFs

    ETF Analysis: First Trust Tactical High Yield

    Find out more about the First Trust Tactical High Yield fund, a debt security-focused ETF designed to produce high income.
  10. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI South Africa

    Learn more about the iShares MSCI South Africa fund, which is an NYSE-listed exchange-traded fund offered and managed by BlackRock.
RELATED TERMS
  1. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  2. Exchange-Traded Mutual Funds (ETMF)

    Investopedia explains the definition of exchange-traded mutual ...
  3. Fintech

    Fintech is a portmanteau of financial technology that describes ...
  4. Indicator

    Indicators are statistics used to measure current conditions ...
  5. Intraday Momentum Index (IMI)

    A technical indicator that combines aspects of candlestick analysis ...
  6. Lion economies

    A nickname given to Africa's growing economies.
RELATED FAQS
  1. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
  2. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  3. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  4. What is the difference between passive and active asset management?

    Asset management utilizes two main investment strategies that can be used to generate returns: active asset management and ... Read Full Answer >>
  5. How are double exponential moving averages applied in technical analysis?

    Double exponential moving averages (DEMAS) are commonly used in technical analysis like any other moving average indicator ... Read Full Answer >>
  6. Is there a situation in which wash trading is legal?

    Wash trading, the intentional practice of manipulating a stock's activity level to deceive other investors, is not a legal ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!