The Russell 2000 Index stumbled last week, forming a bearish reversal pattern on daily candlestick charts off the highs, providing further short-term validation of the powerful double top on weekly charts that was carved out in early June.

There is a lop-sided, but viable head-and-shoulders top on daily charts in the Russell. These formations actually resemble a straight-on shot of a person, with a head top in the middle, and two shoulders on each side. These patterns date back to the beginning of technical analysis theory; these formations simply show a recurrence of selling pressure into the top, then a powerful rejection of buyers away from the top.

To better illustrate how chart action reveals market behavior, think of a plot in the making: right now, the storyline unfolding in small-cap stocks is one of a tired bull market either taking a “breather” to recharge buying energy, or else in the process of forming a commanding top that could foreshadow months of sideways to lower action.

When we step away from the recent topping patterns visible on daily and weekly charts, it should still be noted that the overall trend in the Russell 2000 is toward higher prices. The bull market in small caps has been chugging along now for nearly five years and it would take a breathtaking slide to snap that trend. Still, we study charts to get ahead of decisive price action, not to simply verify trends, and there are plenty of cautionary patterns emerging to warn against runaway bullish enthusiasm along the recent highs.

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