In an incredible show of resiliency, the markets shrugged off another threat of a deeper correction and headed once again to new highs. The bears have to be extremely frustrated by now as each bout of selling has been quickly absorbed by buyers. The bears have been unable to string together more than two days of selling for several weeks now as the markets relentlessly stair step higher. While the markets continue to climb, some market leaders, such as Green Mountain Coffee Roasters (Nasdaq:GMCR) and Amazon.com(Nasdaq:AMZN), are starting to falter. As mentioned last week, the markets are showing some negative divergences and it’s clear that this rally has been losing momentum. This is normal for a rally that has gone uncorrected for several weeks. The markets will pull back at some point, and traders should remain cautious.
The S&P 500, as represented by the S&P 500 SPDRS (NYSE:SPY), was able to get to marginal new highs on Friday, as it cleared the highs set earlier this month. Despite the strength shown in SPY by erasing last week’s distribution day, SPY appears to be in more of a consolidation than a breakout move higher. Volatility is starting to increase a bit and volume is starting to increase without significant price advance. This is typically showing distribution, so traders should remain on alert over the next few sessions. One possible level to watch is the closing relation of SPY to its 20-day moving average. SPY has respected this average recently and a close beneath it would imply weakness.
The Diamonds Trust, Series 1 (NYSE:DIA) ETF, which tracks the Dow Jones Industrial Average, is showing a very similar pattern to SPY. It has managed to clear its prior highs, although not by much. DIA is sitting at new highs while its MACD indicator remains at its lowest level in several weeks. This is an example of a negative divergence, and simply points out that a trend move may be losing momentum. While this is not a reversal signal, it does warn a trader that the move is getting long in the tooth.
The chart for the Powershares QQQ ETF (Nasdaq:QQQQ) is also showing a similar divergence, although it has managed to clear its prior high by a wider margin than SPY and DIA. The $50 level was the area to watch, and QQQQ was able to successfully hold this level on a weekly closing basis. Some tech leaders such as Google (Nasdaq:GOOG) and Amazon.com are beginning to lag, so traders should closely watch Apple (Nasdaq:AAPL) as the highest profile tech leader still acting strongly. If AAPL begins to falter, it would surely have an impact on QQQQ and the rest of the sector.
The Russell 2000, as represented by the iShares Russell 2000 Index (NYSE:IWM) ETF, has continued to maintain its leadership role as IWM cleared its prior highs before other market index ETFs and closed well above them as well. IWM is once again much extended from its 20-day moving average and as such, traders should be cautious about entering new trades in this space right now. However, despite being overbought, IWM continues to show the strongest structure of the market index ETFs and even the negative divergence in its technical indicators is not as pronounced as the others.
As mentioned last week, the fallout following the Goldman Sachs Group (NYSE:GS) fraud charge was only a single distribution day until proven otherwise. The markets responded quite strongly by quickly negating the weakness and trading to new highs this week. The current rally is reminding me of the tail end of the financial crisis, when traders couldn’t believe how the market was dropping every day – only this time, the market’s going up! Ultimately, the markets will need to correct, and this will likely happen when the majority of traders decide that buying the dip is foolproof. While traders should always be cautious and stick to their plans, this becomes even more important when the markets begin to trade at extremes. This is when fear of missing a move becomes most likely as traders see stocks rallying day in and day out. While it’s definitely possible that the markets can continue to rally unabated, the current environment is vulnerable to violent shakeouts, and traders should account for this in their trading plans. By sticking to high-quality setups, traders can continue to take advantage of the great market environment, while avoiding a disaster on a reversal.
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