Downtrend continuing?

Commentary: The stock market took a plunge this past week after the Fed minutes revealed renewed concern over economic growth. The markets had been stalling near important resistance levels, and Wednesday’s gap lower left a lot of damage in its wake. This week’s reversal could prove to be a pivotal turn in the markets, as there is potential that a much larger top will form on the weekly charts. The rally that began in March has retraced about two-thirds of the decline that occurred through the financial crisis. With the markets stalling in this area, some are thinking another bear market could be unfolding. While this theory should not be dismissed, it is still much too early to assume anything more than a pullback is occurring. The case can be made for multiple scenarios and traders are probably better served standing aside until the picture becomes clearer.

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The S&P 500, as represented by the S&P 500 SPDRS (NYSE:SPY) ETF, was never able to get past resistance near $113 last week and SPY entered a free fall. The fact that SPY reversed from this important level should not be taken lightly, and there is the potential that this is the beginning of a new emerging downtrend. Despite the ominous potential, SPY is still technically trading above a couple of important support levels. SPY found support near $106 in mid July before making a turn higher as it tested the June highs. This level is the first level to watch as a drop below $106 will be a hint at a test of the July lows near $101. The $101 range will be the key level to watch on extended weakness, as a drop below this area will hint at a breakdown from a much larger top on the weekly charts.

Source: StockCharts.com

The price action in the Diamonds Trust, Series 1 (NYSE:DIA) ETF, which tracks the Dow Jones Industrial Average, is revealing a failed breakout. DIA was able to clear resistance earlier this week, which resulted in a higher high. This was a bullish development, but DIA was unable to follow through and fell back into the base this week. DIA found some support near its 50-day moving average; the next important level to watch will be near $100. The July low near $95 is a critical level to watch and a break below this level will hint at a newly emerging downtrend.

Source: StockCharts.com

The Powershares QQQ ETF (Nasdaq:QQQQ) also experienced a sharp pullback this week and undercut its 20-, 50- and 200-day moving averages in short order. While the picture looks bleak here as well, QQQQ remains above some key support levels. It looks like $44 will be tested soon, but the more important level to watch will be the bottom of the current base near $41. One factor to note is that volume has been fairly low across all the ETFs. While this could be attributed to the late-summer season, it does provide a glimmer of hope for the bulls.

Source: StockCharts.com

The Russell 2000, as represented by the iShares Russell 2000 Index (NYSE:IWM), was showing relative weakness recently, as it failed to even reach its July high as the other indexes were trading to new highs in August. The relationship of IWM to the other index ETFs should always be monitored as IWM tends to outperform in healthy environments and lag when more market risk is present. IWM tracks small cap companies. Because the catalyst for the current pullback is tied to a weakening economy, IWM took it on the chin this week. IWM was the hardest hit of the index ETFs and could be testing critical support near $58 soon.

Source: StockCharts.com

Bottom Line
The bulls had been showing resiliency over the past few weeks, but ultimately couldn’t push the markets past important resistance areas. The markets are once again approaching what could be a critical turning point. Despite the push to new highs earlier this year, the price action since last September can be best classified as a consolidation. If the markets break under this consolidation, then things could get rather ugly. If the markets can hold in this trading range and eventually break higher, then it’s possible that a bottom will be confirmed. Both scenarios have large implications, so traders will have to be patient and wait for the picture to become clearer. Last week it looked like momentum was slightly shifting to the bulls, and by the end of the week it looked like the bears had reclaimed control. The next couple of weeks should go a long way toward revealing the market’s intentions. Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!