The chart below shows the daily prices for the past year on IWM, the iShares ETF that tracks the Russell 2000 Small-Cap Index, after closing the week at $162.16 on October 5, 2018.
Small-caps outperformed most indexes in the first half of this year because they were viewed as a safer alternative to large-cap stocks that were more likely to be affected by tariffs due to their reduced exposure to international trade. When the risks of a full-blown trade war (at least with Mexico and Canada) began to subside recently, small-cap stocks sold-off quickly. After peaking on August 31 at $173.38, IWM fell to an intraday low of $160.66 on Friday, 7.34% below its all-time high. IWM rallied from its Friday low and finished the week 6.47% below its high.
I drew three main trend lines on this chart. The upper line shows the trend line of higher highs. The middle line shows where IWM found support for most of this past year, outside of the late winter and spring months when it was recovering from recession. The lower line was the line of higher lows and where many technical analysts expected IWM to find buyers. The trend line held support on Thursday amid the broad sell-off, but broke support on Friday when the pressure was too strong.
The 200-day moving average is slightly below the lower trend line and after the trend line of higher lows broke support, the 200-day moving average proved too strong for the bears and prices reversed. IWM traded below its 200-day moving average for two hours on Friday, which might be a warning signal that it could test another dip in the near-term. However, closing above the moving average tilts the momentum back towards the bulls’ side.
Williams %R is one of my favorite technical indicators because it tends to give a clear indication of how momentum within the market is changing beyond the day-to-day or week-to-week trends. In a low volatility market, this indicator is less reliable. I highlighted five of the recent breaks in momentum in red on this chart. The first fall below the oversold level (moves out of the gray oversold and overbought areas are trade signals, not simply being in the extreme areas of the indicator) at the end of January was an accurate sell signal. The next three were false positives. They indicated weakness, but not the beginning of a major price correction.
The most recent sell signal from Williams %R has taken small-cap stocks much lower as highlighted above. The signal that the selling is over won’t be issued until all three timeframes (14, 28, and 56-day) move above the oversold area. While traders might miss the first two or three days of upside prices, waiting to allocate more funds to small-caps will reduce the risk of losses if the slide lower continues.
To help predict what traders should do next, they should keep an eye on all three of these indicators and wait for a better entry point. The 200-day moving average needs to hold support, IWM needs to move above the lower trend line, and Williams %R needs to show a reversal in momentum out of the oversold area of the indicator.
