Russell 2000: Be bullish, but be watchful

Small-cap stocks joined the party along with the Dow (INDU), S&P 500 (NYSE: IVV) and Nasdaq (LN: Q500) to record highs (albeit a day late), proving that Friday the 13th wasn’t so scary after all. For now, the trend remains toward higher prices. If those caught on the short side of this market are also tight on equity, then the move up tends to be exacerbated as they pay through the nose to unload losing trades. It’s worth noting that last week’s charge to record highs included a gap higher open on Thursday – as I’ve said in the past, trading in the direction of a morning gap that is not quickly filled often becomes a big short-term winning trade.

Looking ahead to this week, the big issue right now is to make sure that the Russell 2000 (NYSE: IWM) does NOT set up a double top on the recent highs. Although the index made a new historic peak on Friday, it was only by a few “handles” over the previous highs in late May/early June, and the market needs to avoid turning south off that zone once again to prove that seller resolve in the 850-855 zone is not greater than buyer exuberance.

As you can see on the attached charts, there is a minor divergence between price and momentum peaks on this latest push higher. Similar divergent behavior in recent months resulted in short-term declines, but was not a long-lasting warning signal. Of greater concern is that weekly charts sport a similar divergence, and on those charts, this kind of divergence can be a topping signal.

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