Analysis: Small Caps At Critical Point
31
OCTOBER, 2016
The US small cap index broke down from a small weekly consolidation and penetrated some key support levels. What’s next for this index?
Lets look at both the weekly and daily charts to see if we can imagine some scenarios that might play out in this market.
The two charts below show the weekly IWM ETF. We can clearly see the wide range bar from last week that sliced through some key support levels. When we look to the left along the white horizontal line we can also clearly see four old resistance levels that became support – identified as points 1 – 4. Additionally, you can see two old support levels that are now resistance – identified as points 5 and 6.
However, before we begin to get too excited about this breakdown, lets take a look at the daily charts…
The chart above shows that prices closed last week directly on the 200 period DAILY EMA – that’s the red line. Now, EMAs are simply tools to help you focus in on potentially relevant chart points. In this case, if you look to the left you can see that there is an area of potential support that price can easily flush into. We’ve marked that area in the chart below – its the blue rectangular box.
So, the question of the day is this – is it a breakdown from a sideways line with an opportunity to short the market? Or is it a false breakdown where buyers will step back in once price moves a bit deeper into the support area below the 200 EMA?
Frankly, there is no way to know but here are some ways to construct trades – both to the long side and the short side. Whatever your bias, there is a high-probability trade structure that can be constructed! This ambivalence is why we call areas like these critical points.
Trade Idea #1: Long Trade
If we assume that this is price action is a false break-down in the making then one way to construct a trade is to wait for price to re-assert itself to the long side. This is the safest way to make a long trade but it requires two things:
- Patience
- Giving up some potential gains while you wait for price to prove itself
Essentially you’re going to wait until price closes back above the breakdown point.
Entry: Buy when IWM closes above 121.41
Protective Stop Loss: 117.74 (last week’s low)
Target: New all-time highs
Trade Idea #2: Short Trade
If we assume that the breakdown is real, then its very easy to construct a short trade!
Entry: Short IWM immediately at the market
Protective Stop Loss: 122.61 (last week’s high)
Target: TRAILING STOP using two pivot points back on the hourly charts.
NOTE: If you don’t know what we mean by “two pivot points” then you should sign up for our small coaching group where you can get all your questions answered!
But But But…..How Can Both Trades Be Right?
There are a number of scenarios that can play out where both trades are profitable. For example, lets assume that price continues lower – a trailing stop on a short trade or good tape reading skills can easily lock in some profits. Then, price rallies to our long trade entry point and powers higher.
Remember, a market is made up of both buyers and sellers. Sometimes, its just a matter of degree as to who is right or wrong. In this case, you can scalp some profits to the short side and still ride a bigger win to the long side!
US Stock Indicies Trend Summary
No matter which way you look at things, most of the time frames on most of the US stock indices are in uptrends! Take a look at our trend grid below.
More Charts Of Interest
1. Gold
Gold is officially in a down-trend on the daily charts. BUT, it also is in an area of very strong support.
Additionally, it is now overbought with an “extended” bear flag. We believe there is room to the short side for a scalp or small swing trade but doubt that price will go too much below 1250.
Silver is also showing a similar pattern.
2. Copper
Copper is nearing the upper end of a 10 month triangle. If hourly or daily sell divergences form in this area it would set up a short trade for a move back down to the lower end of the triangle.
You can use your favorite short term oscillator to look for these divergences. We use the equivalent of a 3/10 MACD but, of course, experienced chartists don’t need indicators to spot divergences!
3. Live Hogs
December Live Hogs are in a clear down-trend. But now they are overbought and almost back into a mild resistance area. We believe that any furthur push up in this market will set up a short trading opportunity.
4. GBPCAD
GBPCAD has made it a habbit of creating rectangles and then breaking from them. After a break from the most recent rectangle it has formed the first bear flag – almost retesting the breakdown point. We believe that this market can be shorted for a swing trade.
Long Or Short? That is the question…
Photograph provided by shutterstock.com
Wrap Up
We’re not convinced that the small caps breakdown is real especially when all other timeframes in all other indicies are still in strong uptrends. And the S&P is still in a well defined trading range. So while we can define two very clear trades in opposite directions on the IWM charts we suggest that you play the short trades very close to the vest.
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