Why the Russell 2000 is Not Forming a Top

Many traders and investors like to track how the more economically sensitive small cap stocks are set up to get a hint at the underlying risk appetite of the market. Usually its a good sign for stocks in general when the small cap stocks are strong and vice versa. 

Lets take a technical look at the Russell 2000 Small Cap Index to see how things look:

Weekly bars

Right away I notice the year long price consolidation after a strong rally in 2013. Price can correct large rallies in two ways, through price declining or time (sideways digestion), the most bullish case is when price just moves sideways through time. We are seeing that here.

Second, taking a look at the Relative Strength vs SP500, RUT has stopped declining as it did for all of 2014. The ratio of small caps to large caps is balancing back out. A breakout above 5.86 for this ratio would be bullish for small cap stocks Relative to large caps.

I like to use the MACD as a trend health indicator and in this case it is signalling momentum much closer to a bottom than a top. After testing the zero line and briefly falling below, the momentum has turned back positive and appears to have begun to bounce off the signal line heading higher. You can see how it looked at the end of 2013, the MACD was elevated above 40 and crossing down through the signal line. Clearly a different situation from where it is currently.

Last, looking at just the 20 Week Moving Average (price has been filtered to show general trend direction) it appears that the longer term trend is resuming to the upside. Coming into 2014 the average was very steeply trending. The year of sideways movement can be seen clearly below:

 This is how uptrends signal continuation; after a period of digestion, they resume to the upside, breaking the prior high in the uptrend. I like this view as it removes any bias that noisy price movement can cause.

It looks to me that the Russell 2000 is headed higher in the near future. That will be bullish for small cap stocks and the market overall.

*This theory would be proven false should the Index turn lower and see this trend average slope lower.