Since its March 2020 bottom, we've discussed the Russell 2000, particularly after that nadir, when the small cap index outperformed the other major US benchmarks. The benchmark grew by a whopping 146.40% till its Nov. 8, 2021 record peak.
That gain is almost 10% more than the boost enjoyed by the NASDAQ 100 between its March 2020 bottom and its Nov. 19, 2021 record peak, an event that seemed to excite traders immensely. During the later period, we saw investors rotating between growth and value stocks, a paradigm in which mega cap tech companies represent growth shares (which they are), while small, domestic firms were the poster children for value stocks.
That's when small caps stood out, having provided the most investor value after having been depressed during social restrictions, though recovering during the post-pandemic restarting economy.
However, small caps have now retreated to the back of the equity pack on spiking inflation and the outlook for rapidly rising interest rates. Smaller domestic companies lack the resources to navigate such an environment, unlike multinationals with broader reach. That's when the Dow Jones index, with its 30 mega cap companies, became the investor-favored representative of value shares.
Still, on Monday, the Russell 2000 was one of two of the four major indices that closed higher, and the other index wasn't the Dow. As well, ahead of Tuesday's Wall Street session open, contracts on the small cap index, though in the red, have declined the least at time of writing.
Nevertheless, we're betting this positive interest in the benchmark will be short-lived, both because of the current fundamentals—inflation and interest rates—along with current technical signals.
The Russell 2000 topped out with a falling channel that's still ongoing. After dropping below the bottom of a range since March, presumed to be short profit-taking and speculator dip-buying, the incline formed a rising channel.
Because prices rose as bears exited their positions along with what we interpret to be misguided longs also getting out, the pattern is bearish, confirmed with a downside breakout. After supply drowned out demand, sellers had to lower their offers to attract fussier buyers at lower prices.
The weekly Rate of Change, a momentum indicator, has provided alert technicians a heads up to the downside breakout of the range and the recent flip of support to resistance around the 0 level.
Trading Strategies
Conservative traders should wait to confirm resistance by the rising flag and the range bottom before attempting a short.
Moderate traders would wait for the index to return all the way to the 2,100 level, where the flag meets the range bottom, to reduce exposure.
Aggressive traders could short right now, entering a contrarian trade at this stage, provided they accept the higher risk proportionate to the higher reward of beating other traders into the position. Money management will make the difference between success and failure. Here's an example:
Trade Sample – Aggressive Short Position
- Entry: 2,050
- Stop-Loss: 2,060
- Risk: 10 points
- Target: 1,900
- Reward: 150 points
- Risk-Reward Ratio: 1:15