Will the rally continue?
The markets continued higher this week and have put together an impressive three week rally. Most of the major indexes followed in the Russell 2000’s lead and set new recovery highs. The markets are clearly overbought at this point, but they have continued to show amazing resiliency and have closed higher almost everyday for the past month. Shorts have to be feeling frustrated with how persistent the markets have been in moving higher. Rather than staying in a range, several market sectors have moved to new highs and most of the major indexes are following suit.
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The Russell 2000 has been the clear leader in this market and as the chart of the iShares Russell 2000 Index (NYSE:IWM) ETF shows, it is well past it prior high and sharply higher from the February lows. IWM is clearly extended at this point so traders need to be cautious at this point. However, just because it’s overextended it doesn’t signal a good shorting opportunity. Often, when a market is trending this strongly, it will correct through time in a sideways trading range. The $65 level is an area to watch in the case it does pullback, as this was the prior high in January.
The S&P500 as represented by the S&P 500 SPDRS (NYSE:SPY) ETF was able to catch up to the small cap stocks this week in setting a new recovery high. While it closed weakly on Friday, it did manage to close above the prior high. Much like IWM, SPY is overbought and extended. Many technical pundits will point out a double top scenario, but for a double top to exist, SPY would have to head lower from this peak and break under the February lows and confirm the pattern. The $115 level is an important area to watch, but the $112 area is another area to watch in the case of a deeper pullback. This is about where the 20 and 50-day moving averages are currently, as well as a horizontal trendline marking prior support and resistance.
The Diamonds Trust, Series 1 (NYSE:DIA) ETF continues to lag the other indexes, which isn’t necessarily a negative. The Dow is composed of mostly slower moving large caps, and would naturally under perform in strongly up trending markets. DIA failed to set new highs along with the other indexes this week, but remains on track to test the $107 level. DIA is facing a similar scenario to SPY where traders will call for a double top on weakness in this area, but the bottom line is the markets have shown great strength and it would take a complete change in character to bring that scenario to fruition.
The Powershares QQQ ETF (Nasdaq:QQQQ) were also able to rally to new recovery highs and performed quite well for the week. QQQQ managed to clear the $46.50 level quite easily and followed through by tacking on another point. Much like the other indexes, QQQQ is extended and overbought. The $46.50 level would be the first place to look for support on a pullback and a deeper correction could take QQQQ all the way to $45 and still look healthy.
It’s interesting that the markets were able to clear their prior highs with little effort except for the Dow. The major indexes are clearly overbought and extended, so traders should be very cautious about chasing stocks at these levels. While it’s likely that the markets need a breather, the bottom line is that they are also clearly showing strength. The one sticking point continues to be the lackluster volume. It will be interesting to see if the first real signs of weakness usher in an increase in trading volume. That would be one cue to watch for a more serious pullback. Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!