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The markets have turned bipolar falling sharply and then rallying strongly with the on going political confrontation about the fiscal cliff. Now the market has reached an important level that could lead to another fall.

Fiscal cliff is the term given to the expiration of the Bush Era tax cuts which not only increases income taxes for everyone, but also pushes up the dividend and capital gains taxes substantially. The term also includes the sequestration that will kick in January next year which will result in massive federal spending cuts. All these factors are expected to push the economy into a recession.

Earlier in November there was talk that the discussions on the fiscal cliff were going nowhere, which led to a sharp drop in the market. Next came the talk that White House and the Republicans who control the House of Representatives were making progress. This led to a rally in the market. Now again, there is a stalemate and the market is moving sideways. It is generally felt that the politicians will reach a solution due to which the market has not fallen.

The fundamental traders will cite the fiscal cliff as the reason for the recent fall in the market. Technical traders, on the other hand, will say that the market was already bearish since September and the fall in November was just a continuation of the trend. Please read our earlier article "Nasdaq Confirms Bearish Pattern, Dow and S&P 500 Follow" published on October 16, 2012 which identified the bear trend.

It is very possible that the market rallied over the past few days due to the assurances that the fiscal cliff issue would be resolved. And it is also possible that the politicians would come up with a good solution and the market would continue to rally. But for now the only thing we have is to look at the what the indexes are telling us. They are held in a pause at key areas of technical resistance, which should caution bulls. At the very least bulls should book some profits now and aggressive traders can initiate some short positions.

Let us look at the exchange traded funds of the individual indices which are QQQ for the NASDAQ 100, SPY for the S&P 500, DIA for the Dow and IWM for Russell 2000

QQQ

The Qs are close to the 50-day simple moving average (shown by the blue line), which is an important area of resistance. Notice that the 50 SMA acted as resistance earlier and is shown by the white arrow on the chart below.

(click to enlarge)QQQ

In addition to the 50 SMA, QQQ is at its 50% Fibonacci retracement level with September 2012 peak as the high and the November low as the bottom. The Fib retracement works out to $65.96. The ETF is also just above its gap as shown by the blue rectangle but still in the previous consolidation area that led to the fall. This increases the likelihood of a correction or sideways movement in the index.

Gaps are areas of powerful support or resistance. Gaps happen when prices close at one level and open at a different level the next day. When prices open lower it results in a down gap, which was the case with the Qs and other indexes and it shows oversupply. When prices rally back up to the gap, it often results in a fall again. We also have the commodity channel index (CCI) in overbought territory. But traders using CCI to enter a trade should wait for the index to go above positive 100 and then close below it to buy.

A QQQ rally above $67 would mean that the bear has failed.

SPY

The SPY shows a similar picture with a slight variation.

(click to enlarge)SPY

Unlike the QQQ, SPY has not been able to close its gap which is shown by the blue rectangle. Also the 50 SMA acted as resistance earlier and is shown by the white arrow. Price is right now near the SMA. The index is also close to its 61.8 % Fib resistance level as shown by the horizontal line and the CCI look similar to the Qs. However, a close above $144 will signal a failed bear.

IWM

The small cap ETF is above its 50 SMA, but still in the gap area shown by the blue rectangle which is resistance. It is also between 50% and 61.8% Fib levels, displayed by the two horizontal lines.

(click to enlarge)IWM

However, notice that there is another gap on top where price is right now, which makes a rally more difficult. Finally the CCI looks similar in structure to the other two ETFs.

DIA

The CCI on the Dow ETF is in overbought territory and looks similar to the other three index ETFs

(click to enlarge)DIA

DIA is stuck at its 50% Fib level as shown by the horizontal lines but the 50 SMA and gap levels are higher. This makes it possible for the ETF to rally a little higher. Gaps often act as magnets for price.

Trading strategy

At the very least this is not the time for bulls to buy. If the ETFs break above their resistance levels, it would be a signal to abandon the bear. However for now, bulls should take at least some profits. Aggressive bears can short the market and hope that the fiscal cliff discussions will push the markets down in the coming days.

Source: Time For Equity Bulls To Take A Breather As Major Indexes Hit Supply Zones