What do they say?

Commentary: The markets finally showed some weakness this week with a distribution day logged on Wednesday. A distribution day is a negative day that occurs on higher volume than the preceding day. We have been highlighting upcoming resistance levels for the past few weeks and this is right where the markets have begun to stall. While the markets remain in a strong uptrend, there are some warning signs that a correction may be beginning.

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One of the warning signs was seen in the price action for the the Powershares QQQ ETF (Nasdaq:QQQQ) which represents the Nasdaq 100. This index has been the leader for months and has been trading near 10-year highs. When a market leader starts leading the way lower it often signals a shift in investor sentiment and QQQQ showed much more weakness than its more conservative peers like DIA and SPY. Notice how QQQQ has continued to drop after the distribution day and closed near its lows for the week. This shows clear urgency on the part of sellers and was also a byproduct of poor price action in some of its components such as Apple, Inc. (Nasdaq:AAPL), Google, Inc. (Nasdaq:GOOG) and F5 Networks, Inc. (Nasdaq:FFIV). QQQQ is still in a healthy uptrend but could remain under some pressure moving forward. The most important level to watch in the near term would be lateral support near $54 which would also coincide with its 50-day moving average.

By contrast, the S&P500 as represented by the S&P 500 SPDRS (NYSE:SPY) finished the week well off its lows, although it wasn’t exactly a pillar of strength. SPY started the week by hitting new highs but did encounter resistance as it probed the high $129s. The level we have been mentioning as a possible roadblock is the $130 level which was an important pivot high in 2008. The breakdown from this level precipitated the worst part of the bear market. The real question is how SPY reacts to this initial wave of selling.

The Diamonds Trust, Series 1 (NYSE:DIA) ETF held up the best for the week although this isn’t necessarily a positive for the markets. The Dow has the fewest component stocks comprising it and it was also helped by a strong week in International Business Machines (NYSE:IBM). DIA actually closed out the week in positive territory and could continue to outperform the other indexes if the markets are starting to correct. Typically in times of weakness, money rotates from riskier asset classes to safer classes, like the high-yield large cap names in DIA.

The other index ETF where weakness was very apparent was in the iShares Russell 2000 Index (NYSE:IWM). IWM had a huge red bar on Wednesday and was unable to recover any of it on the subsequent days. In fact, IWM kept dropping and is now under some important lows that formed earlier in the year. It looks like IWM is headed towards at least a test of its 50-day moving average near $76, but the more important level to watch would be near $74. This was an important resistance level that tracked back to 2008 and should act as a support level on a pullback.

The Bottom Line
Traders are now facing a dilemma. The markets have been extraordinarily strong, but are now faced with the possibility of a correction. It is still too early to know if this is simply a few days of selling or the beginning of a deeper correction. The price action in the leading ETFs like QQQQ and IWM are suggesting a shift in sentiment and could be hinting at a deeper correction. It is important to note that the markets remain technically sound so far, and traders must simply be patient and wait to see how the markets will react in the coming days. Despite the fact that many names are well off their highs, the markets are still quite vulnerable to more selling and aggressive buying is likely not the best course of action right now. The bulls have been conditioned to buy each dip and at some point that strategy will likely be punished, even if only for a few weeks. The safer play is to sit back and let the markets digest the recent selling and see if a more clear pattern emerges. 

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By Joey Fundora

Joey Fundora is an independent trader located in South Florida. Joey focuses on using technical analysis techniques to uncover supply and demand imbalances in equities. To see more of his work, visit his site on Stock Chart Analysis.

At the time of writing Joey Fundora did not own shares in any of the companies mentioned in this article.