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Eyes On The Russell 2000 and Watching For Sell Signals

May 22, 2014 | Bear Market and Corrections, Stock Market Outlook

While the S&P 500 and the Dow continue to push back toward their record highs, the NASDAQ and Russell 2000 have a long way to go before recovery. The problem for stocks in general though is that at no time has the market direction sustained a move higher while the broad small caps and NASDAQ have faltered. The S&P can move up but eventually if the small caps and tech fail to follow, the S&P corrects.

Many investors and analysts last week were worried about the collapse of the Russell 2000 to below the 200 day exponential moving average (EMA). Normally when an index falls below its 200 day exponential moving average (EMA) it is a signal that it is not only in trouble but could be on the verge of entering a more severe correction that could move into the realm of a bear market.

Other Signals

But with an index like the Russell 2000 there are better signals to watch and right now the Russell 2000 is not signaling a correction despite falling below the 200 day EMA and struggling to move higher.

Market Direction Health Check-up

The Russell 2000 then is important for the overall health of the market in general. Stocks can fool investors. They can seem to be in a solid uptrend when in fact they are treading water. This is what a lot of analysts think they see in the S&P and Dow. Instead of actually climbing, they think they are witnessing a topping action. Other analysts are advising that they think the US is already entering the next recession and believe that bonds are the proof.

Instead of watching the S&P and Dow, it may be more important right now to watch the Russell 2000 and the NASDAQ for signs that they will recover. It is not important for them to push to new highs, but it is important for them to recover back above their 50 day simple moving averages (SMA).

Russell 2000 IWM ETF Chart

Here is what to watch for with the Russell 2000. I use the IWM ETF to follow the Russell. This ETF follows the movement of the Russell 2000 stock index. In the chart below we can see that the Russell has fallen below the 200 day EMA earlier in the month. It tried to recover the 200 day in mid-May and failed. The pull back that followed set a new intraday low. Since then the Russell has turned more sideways than up. Today it is back trying to close above the 200 day exponential moving average (EMA). There are a couple of problem here that must be resolved.IWM outlook May 22 2014

Besides moving back above the 200 day exponential moving average (EMA), the Russell 2000 must move higher than the previous low to signal a possible bottom has been put in place. That is the first clue to be watching for. The second item to watch is the 50 day simple moving average (SMA) which you can see in the chart above. The 50 day SMA is beginning to fall back to the 100 day exponential moving average (EMA). This is resulting in a narrowing of the trend lines. If the 50 day SMA crosses down and over the 100 day it will confirm a down signal in the Russell 2000.

Watching For A Down Signal

That down signal will be the first such signal since a down signal in December 2012. Prior to that there was a down signal in May to June 2012.In those two instances the 50 day did not fall below the 100 day EMA but the S&P did still correct. Prior to those  signals, the last down signal generated which broke through the 100 and 200 day exponential moving average (EMA) in the Russell 2000 was back in August 2011. That down signal did not recover fully until Jan 2012.

Correction Followed

Each one of these down signals resulted in a correction in the S&P. The August 2011 correction was the deepest at 19%. The May correction was 10% while the December correction was 7%.

Strategies To Use

You can see then that keeping an eye on the IWM ETF or the Russell 2000 can pay back big dividends by advising when to trade to the downside. The rest of this article is for FullyInformed USA Members as I look at the different products available to profit and protect when a signal is sent from the Russell 2000. This article is 2100 words in length and will require 9 pages if printed.

FullyInformed USA Members can can login directly through this link to read the investing strategy notes and trade ideas before markets open for May 22 2014 or they can sign in to the full members site here. Non-members can join FullyInformed USA here or read the benefits of being a member.

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