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

Related Articles
  1. Bonds & Fixed Income

    The Top 5 High Yield Bond Funds for 2016

    Learn about mutual funds and ETFs that invest in high-yield bonds. Read about the risks and rewards associated with investing in high-yield bonds.
  2. Chart Advisor

    Rare Earth Metals Continue To Struggle

    Rare earth metals are used in many of today's products and many investors are wondering if consumer demand is enough to offset the global economic slowdown. We'll take a look at how they are ...
  3. Mutual Funds & ETFs

    3 ETFs to Consider Before an Interest Rate Hike

    Learn about potential impacts of the Federal Reserve boosting interest rates and three ETFs that can help you capitalize on the perceived December increase.
  4. Mutual Funds & ETFs

    A Complete Guide to Tax Loss Harvesting With ETFs

    Using exchange-traded funds (ETFs) to harvest tax losses can be a smart way to maximize your portfolio's tax efficiency.
  5. Mutual Funds & ETFs

    Why ETFs Are a Smart Investment Choice for Millennials

    Exchange-traded funds offer an investment alternative to cost-conscious millennials who want to diversify their portfolios with less risk.
  6. Investing

    Asset Manager Ethics: Acting With Competence and Diligence

    Managers must make investment decisions based on their personal investment process, which in turn should be based on solid research and due diligence.
  7. Mutual Funds & ETFs

    Should Investors Take a BITE Out of This New ETF?

    ETF BITE offers a full menu of restaurants. Is now the right time to invest?
  8. Financial Advisors

    5 Things All Financial Advisors Should Know About ETFs

    Discover five things all financial advisors should know about ETFs, including when ETFs may be a better choice for your clients than mutual funds.
  9. Stock Analysis

    The Top 5 ETFs to Track the Nasdaq in 2016

    Check out five ETFs tracking the NASDAQ that investors should consider heading into 2016, including the famous PowerShares QQQ Trust.
  10. Chart Advisor

    2 Short-Term and 2 Longer-Term Trade Ideas

    Two shorter-term and two longer-term trade ideas to consider, based on trends and the possibility of a breakout.
  1. Should mutual funds be subject to more regulation?

    Mutual funds, when compared to other types of pooled investments such as hedge funds, have very strict regulations. In fact, ... Read Full Answer >>
  2. Do ETFs pay capital gains?

    Exchange-traded funds (ETFs) can generate capital gains that are transferred to shareholders, typically once a year, triggering ... Read Full Answer >>
  3. How do real estate hedge funds work?

    A hedge fund is a type of investment vehicle and business structure that aggregates capital from multiple investors and invests ... Read Full Answer >>
  4. Are Vanguard ETFs commission-free?

    While some Vanguard exchange-traded funds (ETFs) are available commission-free from third-party brokers, a large portion ... Read Full Answer >>
  5. Do Vanguard ETFs require a minimum investment?

    Vanguard completely waives any U.S. dollar minimum amounts to buy its exchange-traded funds (ETFs), and the minimum ETF investment ... Read Full Answer >>
  6. Can mutual fund expense ratios be negative?

    Mutual fund expense ratios cannot be negative. An expense ratio is the sum total of all fees charged by an asset management ... Read Full Answer >>

You May Also Like

Trading Center