After a sharp advance in early October, stocks finally took a breather on Wednesday — and leading things lower were small-cap stocks as represented by the iShares Russell 2000 Index (ETF) (NYSEARCA:IWM).
When this group of stocks makes a notable move, I respect the price action and sit up in my chair — particularly when the price action also takes place at a technically significant juncture. Tuesday’s bearish reversal may now allow active investors to take a stab on the short side in the IWM ETF.
Small-cap stocks tend to have a leading indicator quality that seasoned traders know to respect. The Russell 2000 is also more volatile than its larger-cap cousins and more sensitive to U.S. economic data. Furthermore, a weakening dollar — which we have seen in recent days — doesn’t support the index as it reduces U.S. consumer purchasing power and thus lessens demand for Russell 2000 component companies.
IWM ETF Charts
Moving on to the charts, we see that the IWM ETF in 2013 broke past an important band of resistance that opened a lot of upside.
By early 2014, however, the rate of change of the uptrend slowed and the Russell 2000 began to settle into a consolidation phase that increasingly looks to be taking the shape of a bearish head-and-shoulders pattern. The head of said formation was the rally in the first few months of 2015 with the neckline marked by the red dotted line.
Bears are thus now contemplating whether the index is currently working on the right shoulder of this pattern (blue triangle), which would then ultimately have a good chance of resolving lower toward the blue band and also serve as a retest of this former area of resistance.
To be clear, this is potential price action that could play out over the next six to 12 months, not my immediate-term forecast. There will be plenty of gyrations within this time-frame for active investors to sink their teeth into.
On the daily chart below, we see that since the June highs, the IWM ETF has formed a series of lower highs, each very clearly marked by bearish reversal candles. The last two bearish reversals on Sept. 17 and again yesterday occurred at the yellow 50-day simple moving average.
While the bullish reversal from early October still remains intact, Tuesday’s bearish reversal at the top of the multiweek trading range now allows active investors to lean short with well-defined risk against Tuesday’s intraday highs. Use an initial price target on the downside closer to the $112 area.
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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.
