Reading the tealeaves…
Despite an ominous looking reversal candle that formed on Thursday, the markets basically took a rest break this week. They spent the beginning of the week trading in a fairly narrow range before gapping up and hitting new highs on Thursday, which also happened to be the end of the month and third quarter. After hitting new highs, the markets reversed and traded down for the day on an increase in volume. This reversal has many traders worried of a possible top, and while this reversal may certainly mark a short-term high, the markets remain in a holding pattern above some support levels.

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The S&P500 as represented by the S&P 500 SPDRS (NYSE:SPY) ETF cleared its base a couple of weeks ago and has held above prior resistance near $113 for virtually the entire time. Despite a few blips, the overall action is constructive as the bulls have given up very little ground since setting a higher high earlier in September. The $112-$113 area is starting to firm up as support and should be an important level to watch moving forward. Despite the overall strength, the possibility does exist for a steeper pullback and the $110.50 level may be another area to watch on weakness. This is approximately where the 50-day moving average is and also a level that has seen much trading volume.

The Diamonds Trust, Series 1 (NYSE:DIA) ETF which tracks the Dow Jones Industrial Average also held above its breakout area despite closing slightly lower for the week. The weekly candle printed as a doji, signaling some indecision, but overall the price action remains positive. With DIA possibly stalling, it is certainly a possibility that DIA will pull back and the primary level to watch would be the breakout area near $107. If DIA continues to trade sideways, then this week’s high would be the clear level to monitor. This was the area where the markets clearly saw sellers, and a move above this level could catch some bears off guard.

Tech stocks as represented by the Powershares QQQ ETF (Nasdaq:QQQQ) have clearly seen some selling this week, as every day finished lower than the preceding. Volume has also picked up this week, showing some urgency on the part of sellers and this trend needs to be watched. Much of the decline can be attributed to the overall weakness in Apple, Inc. (Nasdaq:AAPL) this week, which is a large component of QQQQ. However, despite the clear selling, overall QQQQ has not given up much ground and remains above a prior resistance level near $48.75. This would be a level to watch on any short-term weakness, but the more important level to watch would be the $47 level which was cleared in early September.

The small caps as represented by the iShares Russell 2000 Index (NYSE:IWM) finally followed its market peers in setting a higher high this week, as IWM finally got above these highs on Tuesday. The $67.50 level was proving to be quite stubborn, but IWM managed to hold above it on the weekly close, which was an important development. This level held on a few pullbacks during the week, and will be an important area to monitor next week. A failure to hold this level could end up leading to IWM trading back towards the middle of its base near $64-65.

Bottom Line
Despite some sign of weakness, the markets remain above prior resistance levels and have given up very little ground over the past couple of weeks. The tech stocks are the area showing the most weakness, but this should be expected as this group led the way higher and is the most tired. The next couple of weeks will be very important as a light volume pullback could set the stage for a powerful end-of-year rally. However, October has certainly accounted for some scary market pullbacks in the past, and the recent stalling of the markets has many traders worried. Traders should monitor the recent breakout areas as any weakness that drives the major index ETFs below these levels would be a clear warning signal. If these levels hold, the benefit of the doubt would continue to lie with the bulls.

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