Small Cap Relative Strength Breaking Down – What It Means For You

While the Dow, S&P 500 and NASDAQ Composite listed sideways to slightly lower, in what could be thought of as an uneventful trading day, sellers were causing havoc among the smaller companies listed in the Russell 2000 Index.

Typically, seeing small cap stocks underperform prior to a market correction is common, as small caps often experience the greatest gains during rallies and they frequently need a figurative moment to catch their breath afterward. In recent weeks, though, another negative development has been causing concern for this market segment.

Essentially, small cap stocks have been the all stars for most of 2013, with the small cap Russell 2000 Index up nearly 28% year-to-day compared to the S & P 500 gain of 20%. The trend higher in the ratio chart of the Russell 2000 versus the S&P 500 reflects this outperformance since late April. One can also see in the chart below, however, that a key uptrend line in the ratio chart has been broken as of this week. This action, combined with the breakdown below the “Support Zone” in the RSI shown on the graph below the ratio chart, suggests that small cap stocks will continue to underperform.

http://s21.postimg.org/tdq9yxlh3/RUT_Breakdown.png

So what does this mean for you? Well, that small cap stock you own or are thinking about buying is now facing increased resistance to gains compared to its larger cap peers found in the S&P 500, NASDAQ Composite and Dow Jones Industrial Average. In other words; maybe it’s best to put off that new small cap buy. Additionally, those owning small cap index funds should consider shifting some of that money to a large cap fund -- at least until some signs of life appear in the ratio chart.  For now, the bigger (companies, that is) the better.

~D

Profile photo of MetroTraderMetrotrader (D) is one of the few practicing CMTs (Chartered Market Technicians) in the United States . The CMT certifies his knowledge of market timing and risk management approaches. He tends to look for broad market moves and take advantage of them with index funds. The strategy he principally uses is mostly quantitative, and, tested, and has avoided or capitalized on every major recession since the 1940s. He says the best way to make money is to avoid losing it in the first place.

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