Russell 2000: Heroic rally, but still more to prove

The Russell 2000 (NYSE: IWM) staged a heroic recovery rally last week off a test of critical support below the 740 zone. The hard charge off that test marked a rare positive signal in a chart picture that has been dominated by bearish signs since the summer top.

The index climbed through key Fibonacci retracement targets drawn off the December decline on daily charts, which was a good sign, but the market still faces more important upside challenges calculated from the October top. While it might be tempting to call last week’s recovery a “feel good” spark heading into the New Year, that enthusiasm must be tempered.

Looking at weekly charts, there is still a risk for a head-and-shoulders top to play out over the next few weeks if the market does not mount a run back into the October highs. Even setting aside concern from that formation, the Russell still faces the aforementioned Fibonacci numbers from the October peak (50%=793.23; 61.8%=807.11). Until we crack 807, the current recovery move is still technically a correction within the bear market formation and should be respected as such.

In addition, the Russell faces a more immediate test this week on trendline resistance from the October highs. Typically I will not use a trendline for very long – especially one that is steep, as is the one off the October peak – but for short-term purposes it is still worthwhile to watch this week. If that line is challenged, but not smashed, then it gains short-term bearish prominence.

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