The Pullback in the Small-Cap Stocks May Not Be Small

By | September 7, 2017

The iShares Russell 2000 ETF (IWM) has been making a series of higher highs this year in a widening triangle pattern. As the pattern has progressed, the highs have been incrementally higher but the reversions back to support have become deeper and require larger advances in price.

The 7% pullback that followed the July high broke the 200-day moving average and retested the May low. To continue the pattern and achieve a new high will require an 8.5% move off this month’s low, up to the projected trend line drawn off this year’s highs. The IWM looks like it is stalling about half way to its goal and in danger of failing.

The daily chart shows the IWM triangle pattern of higher highs and the main area of horizontal support in the $133 area. Like the megaphone pattern, this triangle requires larger declines and larger advances, and usually the former is easier to achieve than the latter. The dashed line is a regression line or best-fit straight line of price within the triangle borders. It, along with the 50-day moving average, is currently being retested, and just below that intersection of resistance is support between $137 and $138. The integrity of either of these parameters may determine the intermediate-term direction of the small-cap sector.

Daily moving average convergence/divergence is overlaid on a weekly histogram of the oscillator on this chart. While it is making a bullish crossover on the daily time frame, it is doing so with the weekly histogram in negative territory and the stochastic oscillator indicating that the IWM is short-term overbought.

The Chandre Trend Meter, which is an amalgam of several momentum indicators on multiple time frames, has been unable to definitively return to positive territory. A more positive sign, is the Chaikin money flow reading, which is slightly in positive territory.

If positive momentum continues to weaken, and support in the $137 area is breached, that would reflect a failure to make a new higher high, which would invalidate the pattern. At that point, it is likely that downside momentum would pick up, and support in the $133 area would be in jeopardy.

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