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REVERSAL


A Rally In The Russell?

01/24/05 08:45:25 AM
by David Penn

The little guys of the stock market show their muscle with a positive divergence and bullish follow-through in mid-January.

Security:   $RUT
Position:   N/A

The Russell 2000 represents the smallest 2,000 stocks in the Russell 3000 Index. The Russell 3000 represents the 3,000 largest publicly traded stocks in the US. So in terms of stock shorthand, the Russell 2000 is one of the more significant small-cap indexes available for traders.

How have these "little guys" fared in 2005? Well, pretty much as well (or as poorly) as the big boys. Over December, the Russell 2000 created a negative stochastic divergence between the beginning of the month and the middle of the month, then created a second negative divergence between the middle of the month and the end of the month.

Figure 1: Extended high over its 50-day exponential moving average throughout December, the January correction brought the Russell 2000 back to normalcy near its 50-day EMA--to say nothing of a potential return to its bullish ways of late 2004.
Graphic provided by: Prophet Financial, Inc.
 
It was the multiple divergences in December that led to the collapse in the Russell 2000 in January (the second divergence is admittedly negligible in Figure 1; I resort to my eSignal charts, which provide specific indicator values, when it's too close to call on the Prophet.net charts. In the eSignal chart, the second divergence is clear and unmistakable). Painfully for owners of small-cap stocks (but not necessarily for small-cap stock buyers), the Russell 2000 crashed through recent lows early in January and down through the 50-day exponential moving average (EMA) a few days later. This last move also saw the Russell 2000 take out the lows of December as well, setting the stage for a multimonth move to the downside if the bears will have their way.

But the break was so sharp and the declines so swift in coming that a bounce of some sort made increasing sense as the Russell 2000 moved slowly lower over the balance of the first half of January.

However, in this slow movement were the seeds of a reversal in the form of a positive stochastic divergence. Even though the 7,10 stochastic shown in Figure 1 curls upward as the Russell 2000 made its lower lows in mid-January instead of making a clearly demarcated second trough, I believe that the rise of the oscillator in the face of declining prices in the Russell 2000 is a significant-enough warning that the correction in small- cap stocks might be coming to an end.

The deep moving average convergence/divergence histogram (MACDH) trough augurs dangerously for small-cap stocks down the road. But in the intermediate term, small-cap stock investors look likely to enjoy a market rising on the back of true positive divergences. Also of note is the way that the 10-day EMA, which dipped below the 50-day EMA for a few days at mid-month, is now poised to curl back upward and above the 50-day. Finally, the hammer on January 12 provides a potential pivot low against which any near-term declines can be measured. If the lows of the January 12th hammer hold, then a test of the December 2004 highs is the next big technical event to anticipate.



David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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