Rally continuing?

Commentary: The markets essentially traded sideways this week as buyers and sellers struggled to make any headway. In the end, they closed at almost the same place where they opened – although thanks to Monday’s gap, they closed a little higher than they did the week before. With the exception of the Nasdaq, the general markets remain in a holding pattern under an important resistance level. Many traders are contemplating a top in this area, but this week’s price action was actually was quite constructive. The markets have refused to give up much ground and Monday’s gap higher remains unfilled. While this is bullish, traders should note that this is very similar to the price action that occurred in early August at these levels. Suffice it to say, the markets clearly rejected this level last time and it remains a key level to watch going forward.

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The chart for the S&P 500, as represented by the S&P 500 SPDRS (NYSE:SPY) ETF, clearly shows the established trading range. The boundaries for this broad trading range are $113 and $104. With all eyes on the $113 level above, the breakout will be easy to spot if it does occur. However, traders should also keep an eye on the important levels below. A pullback from these levels would not necessarily rule out an eventual breakout. While the August low near $104 is certainly very important, there are a few possible support areas that can support a mild pullback. The 200-day moving average lies near $111.80 and is one area that could attract buyers. Another area to watch would be near $110. This has been an important inflection point over the past several months and is approximately where the 20- and 50-day moving averages will be in a few days.

Source: StockCharts.com

The Diamonds Trust Series 1 (NYSE:DIA) ETF, which tracks the Dow Jones Industrial Average, is following a very similar pattern to SPY. DIA remains just under the $107 level, and has refused to give up much of its recent gains. While the $100 level remains as a key support level, the $105 level is a closer level to watch. There are two gaps in this area and it is an emotional inflection point on the chart. Many shares have exchanged hands at this level and it wouldn’t be a surprise to see increased action here on a test.

Source: StockCharts.com

In a surprise move, the tech stocks, as represented by the Powershares QQQ ETF (Nasdaq:QQQQ), assumed a leadership role this week. QQQQ gapped above the important $47 level on Monday and continued to move higher each day. By the end of the week, QQQQ had cleared even its June high. This is great news for bulls, as QQQQ has set a higher high and is providing leadership for the general markets. The $47 level is now an area to watch for support on a pullback, but there is also the chance that the Qs’ will dip into the unfilled gap just under that level. The next level to watch on the upside is the $49 level, which was an important level back in spring.

Source: StockCharts.com

While the technology sector is showing much improvement, the small caps, as represented by the iShares Russell 2000 Index (NYSE:IWM), continue to lag. While the price action this week was similar to DIA and SPY, overall this group is showing relative weakness. While the other indexes are testing their June highs, IWM remains well below these same levels. If the markets are going to break to new highs, this group will have to participate. If IWM continues to lag, it could lead to a failed move from the other index ETFs.

Source: StockCharts.com

Bottom Line
This week’s price action was very constructive as the markets worked on correcting the recent rally by time rather than price. What this means is that the market is working off oversold tension without any real price movement. This type of price action shows an underlying bid in the market and could be a valuable clue moving forward. The big question facing traders is whether the markets will break above this narrow consolidation or below it. Both scenarios are quite possible and there are plenty of arguments for either case. Because the markets are trading in such a tight range, the eventual break could present a good trading opportunity for prepared traders. The possibility exists for a substantial move in the near future and traders should be ready for both scenarios.

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