The weekly technicals, reading the tealeaves..

July 19, 2009- Market Summary
The markets staged an impressive rally this week after threatening to break down from last week’s topping patterns. The market kicked off the week with a rally in the financials following an upgrade of Goldman Sachs Group (NYSE:GS) by analyst Meredith Whitney, who also had some positive comments on banks. Goldman Sachs followed up by posting an impressive earnings report that topped estimates. Tech stocks, semiconductor stocks in particular, helped the markets continue the rally on Wednesday, following a positive reaction to an Intel Corporation (Nasdaq:INTC) earnings report. (For further reading, see Semiconductors Emerging As Leaders.)

For the week, the Nasdaq Composite gained 130.58 points (7.44%) and the Dow Jones Industrial Average gained 597 points (7.33%). The Nasdaq erased the entire loss from the June highs and the other indexes were able to reclaim a large portion as well.

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Digging deeper into the technical side, the major indexes were able to negate the highly publicized head-and-shoulders topping patterns that were forming. This could be an important development, as many aggressive traders were caught shorting this move, and may now be caught in a short squeeze. Often the strongest moves follow a failed chart pattern, as both sides of the trade scramble to adjust to the new trend.

The Diamonds Trust, Series 1 (NYSE:DIA) ETF, which tracks the Dow Jones Industrial Average, is showing a great example of how a failed move can spark another burst in the opposite direction. DIA broke under a head-and-shoulders pattern last week, but couldn’t manage any significant follow-through. It recaptured the neckline on Monday, and never looked back. Key resistance looms near $89, but it certainly looks like the bulls have regained control.

The S&P 500 SPDRS (NYSE:SPY) ETF was showing a similar topping pattern, it held a key support level at $87. It bounced very sharply off that level, also negating a head-and-shoulders topping pattern in the process. SPY remains in a trading channel and has a critical resistance level near $95. A move above this level would have intriguing bullish implications for the market.

The iShares Russell 2000 Index (NYSE:IWM) ETF also held a critical support level near $47, respecting its prior breakout area. It held above its 200-day moving average and managed to snap back over its rising 50-day moving average as well. It appears a test of the upper boundaries of the established trading range is coming soon. A sustained move above $53-$54 would signal a very positive bullish development.

The Powershares QQQ ETF (Nasdaq:QQQQ) has shown relative strength versus its peers as tech stocks continue to assume a leadership role. QQQQ threatened to break down from a small double top last week, but quickly bounced back into its base, much like the other index ETFs. It was able to clear the prior high and closed above an important resistance level Friday at $37.56. The semiconductors cleared important bases earlier in the week and hinted that the tech-laden ETF would follow up with a similar move.

Bottom Line
While the technical picture for the markets is certainly looking much improved over last week, traders should be aware that there are still some flashing warning signals. While the MACD histogram indicator has turned positive, it is still making lower highs as the markets trade higher. This warns of slowing momentum, and highlights the fact that the markets have yet to stage a healthy correction since the rally began in March. Keep an eye on the resistance levels mentioned, and whether a move above them can be sustained. The possibility still exists for a bull trap to be set, much like the recent failed head-and-shoulders bear trap. If these levels are cleared decisively, they should become important support levels moving forward.

(To learn more about levels of resistance, be sure to check out the Support And Resistance section of our Technical Analysis Tutorial.)

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