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Bulls Beware: It's a Critical Time for Small-Caps

The IWM is trading just below its 2012 peak

by 9/12/2012 10:43:02 AM
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In mid-August, I discussed how small-cap performance had hit a multi-year low, and why I expected the small-caps to lead a stock market rally going forward. As you can see on the relative-strength chart of the iShares Russell 2000 Index ETF (NYSEARCA:IWM) and the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) below, the support level held up as expected, and the IWM has had a very nice run during the past month.

Relative Strength Chart of IWM and SPY
Chart courtesy of eSignal

After a nice rally, there are some pretty significant areas I want to discuss today. As you can see on the chart above, the IWM/SPY relative-strength line is now trading near its upper channel. This has acted as resistance on two previous occasions, so we should definitely take notice. Looking at the chart below, you can also see that the IWM is now trading just below a major resistance area that coincides with its previous 2012 peak.

Weekly Chart of IWM
Chart courtesy of StockCharts.com

My colleague Ryan Detrick mentioned this resistance last week. He notes that it may be part of larger inverse head-and-shoulders formation, which has some very bullish implications. When you combine this price-level resistance with the relative-strength chart above, I'd have to agree that this is a critical time for the small caps. Until I see a break of these key areas, I'd be a little wary of the IWM, though. If it does break above and the relative strength confirms this move, I definitely think it bodes well for a nice rally led by the small caps.

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