By James Hyerczyk
Commodity Trading Advisor
Since bottoming in early June the major index ETFs have zigzagged their way to a more than 50 percent retracement of the major break from late April. Although they looked as if they were poised to complete a normal retracement in a downtrend, the news from Europe on June 29, triggered new demand for equities, sending the iShares Russell 2000 Index ETF (IWM) and S&P Deposit Receipts (SPY) through their respective 61.8 percent or Fibonacci retracement level. The PowerShares QQQ Trust Series ETF (QQQ) is lagging a bit behind, having only recovered a little more than 50 percent of its recent April to June break.
By overcoming a major retracement zone, these ETFs may be telling investors that the worst is over and that real buying is actually driving equity markets higher. Typically in a bear market, the trade will become cluttered with a large number of shorts and very few buyers. This leads to an oversold condition and the start of a short-covering rally. Often if the shorts are indeed in control, the market will retrace into the 50 to 61.8 percent retracement zone created by the last major break, giving the bearish traders a chance to refresh their positions.
During a retracement, the zone becomes an area of interest where both bullish and bearish traders will fight it out for control. Prior to last week’s gap-n-go rally, the major ETFs had already tested their respective retracement zones with the bulls losing the battle to the bears. Now that the news from Europe has helped shift investor sentiment, demand for more risk has increased, causing short traders to cover and back away from refreshing their positions. This has also allowed stocks to rally beyond the typical retracement zone resistance.
There is an old adage in technical analysis which says “old tops tend to become new bottoms.” Now that these major ETFs are trading on the bullish side of their key 50 percent level, it should become new support. A failure to do so will be the first sign of weakness. Furthermore, if the rally continues then the 61.8 percent level should also become support. If you combine this with the retracement zone created by the rally then support clusters may emerge, giving you more levels to watch for new demand or changes in trend.
Last week the SPY gapped higher and regained 50 percent of the break from $142.21 to $127.14 and at the same established support at this level identified as $134.68. Further upside momentum drove the market through the 61.8% retracement level at $136.45.
In addition to the retracement zone breakout, the SPY also took out a swing top at $136.25. This turned the main trend up on the daily chart. If the retracement zone can become new support then the chart indicates there is plenty of room to the upside.
The QQQ ETF had a similar move to the SPY ETF except it is only now crossing the 50 percent retracement level. It has crossed the swing top at $64.57, changing the main trend to up, but the next acceleration to the upside is likely to continue when it breaks through the 61.8 percent level at $65.30. The 50 percent level is now new support so the first sign of weakness will be a failure to hold this price.
The iShares Russell 2000 Index (IWM) is one index ETF that has successfully cleared both major retracement levels and is now in a position to rally further. The next major upside target is the swing top at $82.97. The new support is the 61.8% retracement price at $80.18, followed by the 50 percent price at $78.80.
Since the current up swing is $75.42 to $81.60, a 50 percent of this rally will take the market back to $78.51. This price forms a support cluster with the main 50 percent level at $78.80, making $78.80 to $78.51 an important downside price target should the market weaken.
All of these ETFs are trading in an uptrend at this time. Besides crossing swing tops to trigger the changes in trend, they have also regained key 50 percent levels. Some have even taken out 61.8 percent levels. The combination of breaking out over the swing tops and crossing to the bullish side of major retracement zones has put these ETFs in a position to rally further over the near-term.