By Jeff Clark, editor, Market Minute
The small-cap rally is getting quite stretched. And, the rubber band could snap back any day.
The Russell 2000 small-cap index is up more than 20% in the past seven weeks. That’s a remarkable move, and it has lots of folks looking for even more gains as we close out 2020 and ring in 2021.
But, I’m not so sure…
Take a look at this chart of the iShares Russell 2000 ETF (IWM)…
At first glance, this chart looks bullish. IWM is in a steady uptrend. All of the various moving averages are in a bullish configuration – with the 9-day exponential moving average (EMA – red line) above the 20-day EMA (green line), and the 20-day EMA above the 50-day moving average (MA – blue line).
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There’s no wonder why so many folks are looking for even greater gains in the days/weeks ahead.
But, look at how stretched all the moving averages are from each other. There’s not much energy left to fuel another big push higher.
More importantly, IWM traded yesterday nearly 13% above its 50-day MA line. That’s an extreme move. IWM rarely gets more than 7% away from its 50-day MA before snapping back towards the line.
The last time we saw such a big gap between the price of IWM and its 50-day MA was in early June – just prior to a 10% drop in the small-cap index. The chart today looks quite similar to how it looked back then.
Of course, that doesn’t mean IWM has to fall from here. It could just chop around near its current level for a few weeks and give the moving averages a chance to catch up to the current price. That’s probably the most bullish scenario.
It seems unlikely that IWM would rally strongly from here given its already extended condition. And, even a modest decline back to its 50-day MA would knock it down by 10%.
From a risk/reward perspective, the small-cap sector looks like a poor idea at the moment.
Best regards and good trading,
P.S. During my three-decade-long trading career, I rarely trade the big-name stocks. Instead, I trade this “boring” stock that I know will almost always give me significant returns.
If you want to keep it simple, and only trade one stock, then click here to find out how it could potentially generate consistent gains… and could even fund your retirement, like it did for me.
In today’s mailbag, Jeff Clark Trader member James agrees with Jeff’s Monday essay on making contrarian trading choices…
Jeff, this is excellent advice that needs to be constantly pounded into my dense head. How many times have I let my emotions make the decisions for me and suffered losses?
It’s counter-intuitive to buy more of something when the price drops lower, even though you know you are being presented with an opportunity to buy at a discounted price.
Your newsletter is one of the best investments I’ve made this year. Keep them coming.
Thank you, as always, for your thoughtful comments. We look forward to reading them every day. Keep them coming – and send us any questions – at [email protected].
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