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Dow, Russell 2000 Market Divergence -- Warning or Opportunity?

Stocks in this article: DIA SPY IWM

NEW YORK (TheStreet) -- Anyone watching the markets the past few days feel like they are watching a yo-yo competition. Up one day, down the next, only to reverse even higher the next has investors dizzy when contemplating their next move.

Prior to last week's second consecutive small loss, the S&P 500 (SPY) had been oscillating up and down for the past 10 weeks. In spite of all that daily and weekly inverse action, both the Dow Jones Industrial Average (DIA) and the S&P 500 are still within 1.2% of their all-time highs, which were set just last week! So what's the problem? Everything must be great.

Unfortunately, any time there is back-and-forth vacillation in price movement, it demonstrates confusion within the investment community. In technical parlance, it is called "churning." Churning action near the top price levels for a stock or a market index isn't necessarily a bad thing. However, investors need to keep a close watch for a potentially bad outcome should prices break down.

Let's use the SPDR Dow Jones ETF (DIA) as a proxy. It closed Thursday at $165.18, down 0.18% year to date.

A close below $158.70 would be the signal of a breakdown, and most likely more selling and lower prices will follow. That level breaches both the 200 Day Moving Average and the lowest price traded over the last 14 weeks. The Dow ETF has only traded higher than the December 31, 2013 all-time high of $165.51 on nine days this year. Year to date there has been no gain for DIA, and it's almost Memorial Day!

When stocks or indices consistently try and fail to cross resistance -- in this case the December high -- most times at least a moderate pullback ensues before another attempt is made. It feels like that may be happen sometime soon for several reasons.

A quick look at last year's leading index, the Russell 2000, is a cause for consternation. The price chart of the iShares Russell 2000 ETF (IWM) demonstrates that last year's uptrend has been broken. It appears that it is going to be in full correction mode soon, which is defined as a loss of more than 10% from its previous high. Currently the Russell 2000 ETF is 9% lower than its March 4 level.

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