Russell 2000 Trapped – Showing Relative Strength

Aug 1, 2008: 11:18 AM CST

The Russell 2000 (Small-Cap) Index is currently trapped beneath is key average, hinting that a potential break may be in store.  Also, the index is showing strong relative strength to the Dow, S&P, and NASDAQ, which could be a good sign for the larger cap markets.  Let’s look.

Russell 2000 Index Daily:

The Russell (here-on as $RUT) caught my attention recently, when the S&P, NAS, and Dow all made clearly lower lows in July… but the Russell (mostly comprised of ‘small-cap’ companies) formed a higher low, which is the first step in a potential trend change.  Not to my surprise, the RUT is showing strong relative strength to the other indexes (chart of S&P below).

At the moment, the index has created a new momentum high (but not a new price high) and is stagnating (consolidating) in a range between its key 20 and 50 period EMAs and the falling 200 day SMA.  Once price convincingly breaks one of these areas, a new continuation price swing may lead to a round of profits for those who join the breakout side.

Support comes in around index value 700 and resistance comes in around value 720.  Notice that a small symmetrical triangle is forming (not drawn).  The break of the triangle could lead to a quick trend move, especially if price pierces its key moving averages.

Speaking of relative strength, let’s compare the Russell to the S&P 500:

Russell to S&P Relative Strength:

Earlier this year, the S&P outperformed the Russell, but since June, small caps as a whole have outperformed larger cap issues.  The “Blue Line” for the Russell overtook the “Black Line” for the S&P at this time, which is evidenced by the ratio chart in the bottom panel.  With relative strength rising, one could have hedged long the Russell and short the S&P and profited from that balanced hedge.  Or, one could have traded more aggressively in small-cap stocks.

Although I don’t discuss it much on the blog, you should always pay attention to relative strength relationships and assess whether the RS Line (one security divided by another or an index) is rising or falling.  Relative strength tends to be a sustained relationship, and often RS shifts (changes) will occur prior to actual price shifts, so it’s important to keep an eye on this ‘indicator.’

We’ve made it through June and July, and August is sort of a transition month in the market so it will be interesting to see if a clear direction emerges, or at least if volatility calms down a bit – this has been a much more active summer than expected.

1 Comment

One Response to “Russell 2000 Trapped – Showing Relative Strength”

  1. Hank Says:

    But doesn’t IWM look like distribution? Large volume but going no where… I think IWM should be heading down from here…