• Why Small Caps are Predicting a Market Rally

    by  • December 13, 2012 3:24 pm • Quick Hits • 0 Comments

    Today I want to focus on the relationship between small cap stocks and the overall market. I like to see small cap stocks take the lead, as it tells me investors are increasing their risk appetite and is a good sign for the longevity of a rally. I have used price level support/resistance and relative strength between the IWM and SPY to get a good gauge on price action during the past several months.

    On August 15, I noted that the IWM/SPY relative strength line was trading near multi-year support area, presenting a good buying opportunity. Fortunately, during the next month the IWM rallied more than 8 percent. On September 12, I once again discussed how the IWM/SPY relative-strength line was trading near upper channel resistance. In addition, I noted that the IWM was trading below major price-level resistance. The market rallied for a few days, but ultimately declined more than 9% during the next two months.

    Well, after rallying from the November low, there has been a critical development in this relationship that nobody is talking about. As you can see in the IWM/SPY relative strength chart below, we have finally seen a breakout above the upper channel resistance line. This is a very encouraging sign.

    Taking a look at the IWM chart below, I see a couple interesting things. IWM was just rejected by resistance near the $84 area, but there has been another major development. On November 29, IWM broke above a descending trend line, which also coincided with former price resistance near the $81 area. From a short-term perspective, it is trading near $82, which was the site of a congestion area during the past couple weeks. Aggressive traders may look to enter here, but a retest of the $81 level is still a definite possibility.

    So, what’s the bottom line? Taking into consideration price support just below and the key development on the relative strength chart, I think IWM could be a nice buying opportunity over the next month or two.


    Joe Bell is a Senior Equity Analyst and works on the trading desk at Schaeffer’s Investment Research. He joined Schaeffer’s in 2006, and has more than eight years of experience in the financial services industry. Joe has been quoted in national media outlets such as Reuters, TheStreet.com, SmartMoney, WallStreetJournal.com and the Associated Press. In addition, he is an experienced presenter on options and trading, with experience presenting at live seminars, college universities, and online webcasts. His strengths include short-term trading and advanced option strategies, with a focus on technical- and sentiment-based analysis. Joe originally hails from Columbus, Ohio, and earned a B.S. in Finance and an M.B.A. from Ohio Dominican University.


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