The small-cap Russell 2000 index — as represented by the iShares Russell 2000 Index (ETF) (NYSEARCA:IWM) — rallied 0.60% on Feb. 15. While in absolute terms this rally may not sound like much, it did confirm the “chart breakout” it accomplished earlier in the week. Traders would be wise to respect this breakout until the next bearish reversal appears.
The thing about trading breakouts is that psychologically once a breakout occurs many traders find it difficult to buy the stock or index in question as they feel to have already missed the move.
While breakouts certainly can be short lived, over time, respecting a breakout and trading in the direction of the breakout offers better odds than attempting to ‘fade’ or fight it.
Looking at the U.S. stock market from 30,000 feet, we note that after it made a two-month sideways march, this week has offered renewed sector and group rotation. The rotation is what helped push indices such as the IWM exchange-traded fund higher. The importance of sector and group rotation in the stock market cannot be overstated for these movements, where opportunities lie for active investors and traders to outperform the broader indices.
Additionally, depending on which sectors lead or lag, we can derive the probabilities of a directional move higher or lower in the broader indices.
When I last discussed the state of the Russell 2000 on Nov. 21, I pointed to the near-term overbought readings. Specifically, I offered that in order for the IWM ETF to reach my 2016 year-end upside target between $135 and $140, a little price consolidation first has to occur. Over the ensuing two weeks, this consolidation period occurred and led to a final year-end rally into $138.70.
IWM ETF Charts
However, after reaching its December highs on Dec. 9, IWM — much like the broader stock market — slipped into a boring two-month sideways range, which did not begin to move higher (i.e., break out) until earlier this week.
On the multi-year weekly chart, we see that the IWM ETF is now on its way to retest the upper end of its multi-year channel, which I marked with the two purple parallels.
The upper end of this channel currently comes in around the mid $140s, which in this time frame could now serve as the next intermediate-term upside target.
On the daily chart below, we see this two-month sideways move in the IWM ETF more clearly. Note that the yellow 50-day moving average came in as support on a daily closing basis in January.
The breakout of the sideways range in recent days comes as the index from a momentum perspective on the above weekly chart remains well overbought; note the MACD momentum oscillator at the bottom of the chart.
From here, active investors and traders looking to trade this breakout could use next upside targets with 1% – 1.50% increments while respecting any daily bearish reversal as a stop loss signal. For now that would call for a next near-term upside target around $141 – $141.50.
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