Russell 2000: Play the IWM ETF Long … Then Short!

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Small-capitalization stocks — as represented by the iShares Russell 2000 ETF (NYSEARCA:IWM) — recently took a turn for the worse after showing mixed signals for the first half of 2015.

beatthebell_185x185The IWM ETF now sits at a technical juncture where active investors and traders can clearly define a downside target should markets get more volatile in the August to October period. (A very real possibility.)

When looking at the Russell 2000, there are two big-picture things to keep in mind:

  1. The companies in the Russell 2000 generate the vast majority of their revenue within the United States and are thus a better indicator for the U.S. economy than the S&P 500, which has a good chunk of international revenue.
  2. As a result of the first point, from a price action perspective, the Russell 2000 has a tendency to act as a leading indicator for U.S. stocks. So if the index shows relative strength or weakness versus, say, the S&P 500, the broader U.S. stock market eventually tends to follow the Russell 2000.

With these two points in mind, let’s look at the relative picture of the IWM ETF versus the S&P 500 ETF (NYSEARCA:SPY).

The ratio chart below, where I divided the IWM ETF versus the SPY, shows the relative strength of the Russell 2000 from October 2014 into June of this year, which helped support the broader market and in part kept markets range-bound and choppy. In late June, however, this ratio bumped into the black horizontal, which has acted as resistance since April 2014.

Since finding resistance, the Russell 2000 has shown notable relative weakness versus the S&P 500, which in the meantime has also led the ratio to break below the uptrend line from last October. From this perspective, the ratio has plenty lower to fall.

IWM vs. SPY
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IWM ETF Charts

Moving over to the multiyear weekly chart of the IWM ETF, we can draw two simple lines of support. The first (lower) line of support is drawn off the 2009 financial crisis lows and currently comes in around the $109-$110 area. The second line — currently coming in around the $115 area — is drawn off the 2011 reaction lows and connects the corresponding lows from 2012 and 2014. All the while, the year-to-date slow rise in the Russell 2000 came on lower momentum, which is not supportive of a sustainable rally.

IWM weekly chart
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On the daily chart, we see that the price action since March in the IWM ETF has carved out a head-and-shoulders pattern, which by definition is bearish. The neckline of this formation (blue horizontal box) connects all the lows since March and currently comes in around the 200 day moving average (red line). A measured price target of this head-and-shoulders pattern is near $110 and thus coincides with the lower up-trend line from the above chart.

On Tuesday, the IWM left behind a bullish reversal candle that could lead to an immediate- to near-term bounce into the low to mid-$120s. Beyond that, however, there is too much weight on the index, particularly after making a lower high in mid-July versus its June highs.

IWM daily chart
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Active investors and traders could look to play the IWM ETF long for a real quick bounce, but look to take profits in the mid $125s and flip short for a bigger move toward the $110 area (and possibly lower) in coming weeks/months.

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Successful trading and investing starts with a plan. Download Serge’s essential trading plan, The Essence of Swing Trading e-book. As of this writing, he did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/07/trade-russell-2000-iwm-etf/.

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