Today is the day many market participants have been waiting on for months. The Federal Open Market Committee (FOMC) is set to make its next statement on its outlook for the economy … and interest rates.
Earlier this week, here and here, I have discussed how today’s announcement will likely cause stock correlation to spike in the near term, and that through the lens of risk management it is wise to refrain from trading too many single-name stocks and instead focus on the big picture and on the indices such as the Russell 2000.
The Russell 2000, for its part, has in recent weeks outperformed its larger peer, the S&P 500, which in the near term is at least one reason why the broader market may have one more bounce left in it — and why leaning short the indices is not yet as high-probability trade as it could be.
The Russell 2000 has shown relative weakness and relative strength versus the S&P 500 off and on year-to-date and while breadth is also thinning for the Russell. And in general, it’s difficult to be bearish when small-cap stocks (like those in the Russell 2000) are showing this kind of relative strength.
Russell 2000 Charts
On the below chart, I overlayed the iShares Russell 2000 Index (ETF) (NYSEARCA:IWM) in blue with the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) in red.
Note how the red line recently made a lower high versus its May highs while the blue line is pushing up against the year-to-date highs. On the bottom part of the chart, I plotted the ratio of the IWM ETF versus the SPY ETF, which clearly has been trending higher again since early May (i.e., showing relative strength by the small caps/Russell 2000).
In the bigger picture. the Russell 2000 is (just like the S&P 500) showing plenty of negative divergence between price (higher) and momentum oscillators (lower highs), which ultimately should weigh on the index for a better corrective move — likely in coming months.
On the daily chart below, however, we see that the Russell 2000, as represented by the IWM ETF, has found solid support since early May at its 100-day simple moving average (blue line). We also see, as indicated by the series of green arrows, that the index has seen a plethora of bullish intraday reversals, proving support for the index.
With the two-day rally, the IWM has once again given investors a bullish reversal that now has it pushing up against a very well-defined horizontal line of resistance that stretches back to March.
All this depends on the FOMC statement today, of course, but from a trading perspective, the Russell 2000 has upside potential to 1,300, which roughly translates into $130 for the IWM ETF.
Any bearish reversal that sees a daily close below the 100-day MA would confirm a medium-term top.
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Download Serge’s trading plan in the Essence of Swing Trading e-book here. As of this writing, he did not hold a position in any of the aforementioned securities.
