Sell-off continuing?

Commentary: The markets attempted a breakout Tuesday, following the long holiday weekend with a gap above the recent channel. After some intraday weakness, they recovered to close near their highs leaving market participants optimistic about a rally. However, things became unraveled Wednesday, as the markets reversed and wiped out all of last weeks gains in short order. While the market has not really confirmed a top, it continues to show weakness and each of the index ETF’s we follow are well below their 50-day moving averages and showing an increase in volume as they drop.  

The S&P500 as represented by the S&P 500 SPDRS (NYSE:SPY) sliced back through its 50-day moving average after reclaiming it last week. It didn’t find any buyers on this trip through the average and went on to make new lows. This puts the markets in a precarious position, as it is falling under the prior channel it was following, only days after attempting to clear it. The April lows are the level to watch in the coming days to see if SPY can attract buyers in that area. In either case, traders are likely better off simply waiting. Buying the dip is dangerous at this point, and shorting after the sharp move lower is too risky as well. (For more, see Support & Resistance Basics)

The Diamonds Trust, Series 1 (NYSE:DIA) ETF also reversed after attempting to clear its recent channel and actually is well beneath the channel now. Much like SPY, the April lows are worth keeping an eye on to see how it reacts to what should be support. However, even if DIA finds support, it will likely take some time to repair this week’s damage.

 In an interesting move, the Powershares QQQ ETF (Nasdaq:QQQ) ETF ended very close to last weeks lows despite the sharp mid-week reversal. This is a subtle sign of relative strength, although not really actionable yet. QQQ has also managed to stay near the April breakout above the inverse head and shoulders pattern. However, QQQ is beneath its 20 and 50-day moving averages and likely needs more time to try and stabilize. Despite what appears to be a sliver of relative strength, QQQ is still vulnerable to more downside. Traders need to tread carefully until a more clear pattern emerges. (For more, see Channeling: Charting A Path To Success)

The iShares Russell 2000 Index (NYSE:IWM) ETF is in a similar position to QQQ. It finished the week pretty close to last weeks lows after a very weak Friday. However, IWM is in a clear pattern of lower highs and is also well beneath its 20 and 50-day moving averages. Much like with the other indexes, traders are likely better served waiting patiently for the markets to stabilize.

 Bottom Line
While the markets have been sending mixed signals recently, there was no mistaking this week’s action. The markets reversed sharply after a weak breakout attempt and are back to multi week lows. They are also mired under their 20 and 50-day moving averages after falling on increased volume. The market certainly appears to be topping out as we head into the summer trading season, although I hesitate to say it due to the weekly chart still showing an uptrend. In either case, what is important for traders is to realize that the environment is fraught with risk right now. There are times when it is better to reduce exposure to the markets and wait patiently for the markets to give you an opportunity. This is likely one of those times. If you are still holding several positions, make sure it is because you have a specific plan you are following and not because you are stuck and unwilling to take a loss. If the markets have a full fledged correction, its possible that much lower prices can be seen fairly quickly. Next week will surely shed more light on where we stand.

Read, learn, discuss, and share all about trading at TradersLaboratory (TL), the leading online trading forum for day traders, swing traders, and active investors