The Weekly Charts

Any clues for next week?

Well, you don’t see that every week. The markets dropped in epic fashion earlier this week as the Dow Jones retreated almost 1000 points intraday on Thursday. What started off as weakness generally attributed to concern over Greece and Europe eventually built up enough steam to trigger some unknown chain of events that snowballed into a crash. There have been rumors of a hedge fund blowing up, a “fat finger” error by an institutional seller and algorithmic computer programs gone wild. The bottom line is we will likely not find out what really caused the crash, but there is still plenty for traders to analyze in an effort to interpret what the markets are telling us.

Recently, we have mentioned how several market leaders were beginning to suffer from institutional selling and how the markets were starting to show cracks in its foundation. While a healthy pullback was expected, this week revealed just how fragile the markets are right now. Below is a weekly chart spanning the past three years for the S&P500 as represented by the S&P 500 SPDRS (NYSE:SPY) ETF. Sometimes it is important to step back and evaluate longer term charts to get a feel for the big picture. In looking at this chart one thing that pops out at you is how SPY failed right at the same level were it really broke down during the height of the financial crisis in 2008. This level now takes on even more importance, and this could be an important top for an extended period. The reversal from this level was very sharp and on huge volume. Another thing that stands out is the volume at this level as shown by the price by volume bars on the left hand side of the chart. The more volume involved in a price level, the more importance that level becomes. This is because more market participants are involved at this level and thus more emotions are tied to it. There are two clear levels on the longer term charts that could act as the boundaries for a new trading range based on the volume by price bars. The recent high just above $120 is one level and there is another level near $90 that marked the breakout area from the bottoming pattern back in 2009.

The Diamonds Trust, Series 1 (NYSE:DIA) ETF which tracks the Dow Jones Industrial Average is showing a very similar pattern to SPY. It reversed from an important level on a sharp increase in volume as well. While the markets have been on a strong rally for several months, taken in context, the markets have basically retraced about 2/3rds of the prior decline. DIA is also showing two longer term levels to watch moving forward much like SPY. The $113 level and the $90 level should be important from a technical perspective based on the price action that has occurred there. There is also an important support level near term near $100. This is the area that contained the last pullback in February and where the markets bounced this week.

It’s much of the same story for the Nasdaq as represented by the Powershares QQQ ETF (Nasdaq:QQQQ). The $50 level will be huge moving forward as traders will fear another reversal from this level on a subsequent test. The $40 level will likely provide near term support on continued weakness, but the longer term support level that stands out to me is near $32-$33.

The Russell 2000 has been leading for the past few months, but it also started to falter recently. The Russell as represented by the iShares Russell 2000 Index (NYSE:IWM) ETF is showing the same pattern present in its large cap peers. IWM reversed sharply from the $75 level confirming this area as resistance. Notice the failed rally attempts uin this area back in early 2008. Also, notice how the price volume bars are showing the largest concentration of volume over the past few months occurring at this level. All of this is pointing to this level being extremely important for IWM.

Bottom Line
While we have been preaching caution for the past few weeks, the trading action this week is ushering in a new sense of urgency for many traders. Many investors are concerned with the ease in which the markets sliced through buyers this week, and there is a real concern that market participants will take the next opportunity they get to reduce exposure to the current market. This is how levels become psychologically tied to market participants, and how traders behave in the next few weeks will offer much more insight into the next trend move. The markets have shown a very clear level where sellers overwhelmed buyers and this area is also significant on the longer term charts. Traders should be extremely cautious until this level is cleared. If the markets continue to weaken, there are some intermediate levels that should offer at least a reflexive bounce, but with the severity of this weeks drop, it is not out of the question that the markets are headed for a test of these longer term support levels.