What do they tell?

Commentary: This was one of the most volatile weeks the markets have had in quite some time. The markets began the week attempting to bounce from near term oversold conditions and rallying to the prior weeks highs. However, they gave way to steep declines on Thursday and most of Friday on a large increase in volume. By mid-day Friday, it seemed like the indexes would finish off the week at their lows but in the afternoon the bulls mounted a strong assault on the bears, firmly reversing the intraday trend. All the indexes finished with slight gains on huge volume, while trading well off their intraday lows and forming a candle pattern commonly referred to as a hammer.

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The hammer can be seen quite clearly in the S&P500 as represented by the S&P 500 SPDRS (NYSE:SPY) ETF. The candle is called a hammer because it has a long lower portion resembling the handle coupled with the upper portion acting as the hammer head. The long lower portion indicates buyers stepping up and pushing the ETF’s price well off the lows. This candle can often show a near term turning point, as it shows a complete change in character for market participants. Sellers were well in control pushing the ETF well into the negative column, but by the end of the day had lost complete control to the bulls.

The Diamonds Trust, Series 1 (NYSE:DIA) ETF also shows a similar candle pattern. The reversal also occurred in an area of expected support, which shows buyers were willing to come in at these levels. The $100 level for DIA corresponds with the 10,000 level for the Dow Jones Industrial Average which has been an important psychological area for the markets. The lows underneath the hammer are now an important line in the sand for market bulls. While it appears the bulls have stepped up and defended an important area, there is still much work left for the bulls. The markets remains beneath falling moving averages and under a large price cluster.

This also quite evident in the smallcaps as represented by the iShares Russell 2000 Index (NYSE:IWM) ETF. Despite the strong intraday reversal, IWM remains below the majority of even Thursday’s trading action. Often the strong reversal at support is merely the first step in a stabilization process and the markets will often return to test this level after the initial bounce. For IWM, $58 will be an important area to hold as support as it attempts to consolidate the recent declines.

The Powershares QQQ ETF (Nasdaq:QQQQ) have been one of the weaker groups recently, but started to reverse earlier than its counterparts intraday on Friday. This was one of the first clues that hinted at the hammer being formed. If the markets are going to put in a near term low in this area, then this group will need to continue resuming its leadership role. Much like the other ETF’s, the lows under the hammer have now become an important line in the sand and would need to hold to stave off a more serious decline.

Bottom Line
While the hammer can show a change in character, it does not offer any insight into the strength or target of a reversal. It merely shows that the bears were losing steam and that there are buyers at this level. What happens over the next few days will have important implications for the next intermediate term move. The markets have drawn a line in the sand dividing a run of the mill bull market correction, from a more serious top being put in place. A move of consequence below the hammers on these charts could signal a major trend change and will be a key level to watch moving forward. There is still excess supply that will need to be absorbed and the next few weeks could be messy for traders on either side. It will be interesting to see if the bulls have staved off a top to the current rally.

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