After breaking out on the first trading day of the new year, the markets have now spent the rest of the week wandering back and forth like confused tourists. You have the bulls saying “i know its this way” while the bears keep saying “no, no, I think we passed it, lets turn back around”.
While we've hammered out new recent highs in all the indexes, a noticeable divergence has begun to appear as the small caps as shown by the weakness in IWM (Russell 2000 index etf)as opposed to the relatively stronger charts in both SPY (SPDRs S&P 500 etf) and QQQQ (Powershares QQQ etf). Also, all the charts have shown increasingly noisy chart patterns as volatility has expanded during this weeks consolidation. While I certainly an not telling anyone to short during the current #buythedip, #qe2 environment, I would advise those that are uncomfortable with the current action to begin locking up profits and keep a tighter eye on stops as the next couple of weeks play out.
While the benefit of the doubt should go to the bulls during this current rally, I would also advise caution as the markets are in a tricky spot here at the start of the year. On the one hand, we have potential for a nice short squeeze as many traders may try to jump the gun and begin shorting extended charts prematurely, but we also have the potential for a swift pull back if we break down from here and trap any overly exuberant bulls that over bought this week.
Examining a 3 month daily chart of SPY, we can see that we have been steadily stair stepping up after a key breakout last december. Technically speaking, SPY is currently in a healthy uptrend and has not even come close to testing its 20 day moving average during this run.
During the same 3 month span, QQQQ had a much longer consolidation phase after the breakout in early december, but has shown the greatest strength of the three major indexes as it has made new highs almost every day this week. While today's hanging man candle is somewhat ominous as it shows that selling pressure is starting to build, I would wait for further confirmation such as a break of the currently ascending trendline or 20 day moving average before I would even begin to consider bearish possiblities.
While IWM has been the leader during the current rally, it has shown the most noticeable weakness this week. It actually failed its breakout level, but was able to hold its current base after dipping down below it and its key 20 day moving average twice. While this could be a sign of healthy sector rotation, it can also be a sign that money is flowing to less risky equities in a “risk off” environment.
After examining these charts, I would recommend a cautiously bullish approach until the bears can prove that they have gained control over the current markets. This means I will trade more selectively, in smaller size and when in doubt, I will “LOCK IT UP!”
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