Market getting choppy, risk increasing….

The Weekly Report For May 23rd – May 27th, 2011

Commentary: After a weak start, the markets rebounded and continued their consolidation this week. Following Monday’s reversal, the market saw a gap down on Tuesday that carried it to its lowest level in months. However, the markets rebounded off their lows and managed to climb back to new highs for the week. Much like last week, little overall progress was made, although there was plenty of volatility, especially after a weak Friday. However, the markets did survive a key test of gap support as buyers stepped in at this week’s low.

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The S&P 500, as represented by the S&P 500 SPDRS (NYSE:SPY), tagged its 50-day moving average earlier this week as it partially filled the bullish gap it left on April 20.  Buyers quickly stepped in and bought the weakness, which resulted in a hammer candle being printed at key support. This low is now the key area to watch, as a close below this level would imply a possible retest of the last pivot low near $129. This week’s highs are also important to watch, as the markets are following a well-defined channel as they consolidate. A break above the channel could lead to a test of this year’s high.

Source: StockCharts.com

The Diamonds Trust, Series 1 (NYSE:DIA) ETF followed a similar pattern to SPY, but continues to show relative strength. This could be due to the fact that DIA represents fewer stocks than SPY, and also because it is shielded from several mid cap stocks. Regardless of the reason, DIA held above the bullish gap it left in April, and this area could still act as significant support on a breach of this week’s lows. DIA is following a similar channel to SPY; a break above it would be noteworthy.  (For more, see Channeling: Charting A Path To Success.)

Source: StockCharts.com

The Powershares QQQ ETF (Nasdaq:QQQ) suffered through much more selling than either DIA or SPY as it fell under its most recent trading range and tested the $57 level. This was an important level, as it coincided with its 50-day moving average and was near its prior breakout point. QQQ did rebound from this level, making it a critical area to monitor. A drop below this level would nullify the inverse head and shoulder pattern that developed a few weeks ago. This failure could lead to a longer term reversal.

Source: StockCharts.com

The iShares Russell 2000 Index (NYSE:IWM) ETF actually spent a couple of days underneath its 50-day moving average early in the week. It was the only index to close under the average for any period of time, which suggests that investors are becoming more defensive. However, IWM did survive another test of the $82 level, and this remains the key level to watch. A break below this level would hint at a much deeper correction.

Source: StockCharts.com

The Bottom Line
Despite what has felt like a weak market, the indexes remain fairly close to multiyear highs. However, there are also some subtle signs of a shift in investor sentiment, so traders need to stay on their toes. Large cap stocks have started to outperform small cap stocks, and this reveals a more defensive posture from market participants. Commodities have also been hit pretty hard as the dollar has strengthened a bit. However, until the markets begin to follow a pattern of lower highs and lower lows, it would be dangerous to assume that anything more than a consolidation is occurring. If the markets clear the recent channels they have been following, it’s possible that new highs can be attained. However, a drop below this week’s lows could signal the start of a summer correction.

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