It’s time to wipe the egg off my face… again.

Last month, I warned of a possible decline in the Russell 2000 ETF Index (IWM).

It was overbought, and it was trading 13% above its 50-day moving average (MA) line – an extended condition. And it seemed like a poor idea, from a risk/reward perspective, to buy into the small-cap sector.

Here we are, less than four weeks later, and IWM is 8% higher.

Look at the updated chart…

The IWM uptrend paused briefly at the end of December. But, it has exploded higher this month. All of the moving averages are rising along with it. It didn’t matter that the index was overbought and overextended last month. It kept moving higher anyway.

Lots of folks are betting the trend will continue.

And, just like last month, I’m not so sure…

Yes, I was wrong last month. And, maybe I’ll be wrong this time, too. But, since IWM rarely gets more than 7% away from its 50-day MA before snapping back towards the line, it still seems like there’s a lot more risk than reward to buying the small-caps here with IWM 13% above the line.

Plus, there’s this chart…

This is a chart of the Volatility Index for the Russell 2000 (RVX). And, it’s perhaps the scariest chart in the market.

RVX recently closed above all of its various moving average lines. And, those lines have moved into 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 MA (blue line).

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If this was the chart of a stock, then I’d be looking to buy it – because you can see what happened when the chart showed similar conditions last February. RVX sure looks to me like it’s setting up to explode higher. And, a rise in volatility usually goes along with a fall in the underlying index.

Of course, it doesn’t have to happen that way. As I mentioned last month, IWM could work off its overbought condition by simply chopping around its current level for a few weeks. But, with RVX morphing into a bullish setup, it increases the odds of a more significant decline in the small-cap sector.

Either way, at the risk of having to wipe more egg off my face next month, buying the small-cap sector right now looks like a poor idea.

Best regards and good trading,

Jeff Clark

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Reader Mailbag

Do you think the trend will continue to move higher in the market, or do you agree more with Jeff’s contrarian perspective?

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