Small-Cap Indexes: Technical Tuesdays with Mark Bail

Sep 13th, 2005 | By Penny Sleuth Contributor | Category: Investing Strategies, Macroeconomics

Mark Bail examines two Small-Cap Indexes: The Russell 2000 Growth Index and the Russell 2000 Value Index.

Without further ado — indeed, without any ado at all — Mark Bail.

Thanks, Carl.

Hello again, Sleuths,

Two weeks ago, when I began writing a “Technical Tuesday” column, I discussed the different types of moving averages. And I concluded by saying that I would offer up another serving to describe some ways to use moving averages to improve your trading and investment decisions.

However, before I conclude my analysis of moving averages, Carl has entreated me to put my technical analyst hat on and give you my take on a couple of small-cap indexes. I hope you will find this useful, as I know many of you Sleuthers focus on smaller capitalized stocks. But in a future issue, I’ll detail some ways to put moving averages to good use. So stay tuned.

At Carl’s request, I took a look at the Russell 2000 Growth Index (RUO) and the Russell 2000 Value Index (RUJ). (All numbers I cite are as of the close of trading on Monday, Sept. 12.) Here’s what I found:

Small-Cap Indexes: Russell 2000 Growth Index

The Russell 2000 Growth Index has been in a long-term uptrend since April 29. Except for a hiccup in late June that saw the index pull back to its 50-day moving average, the Russell 2000 Growth Index performed masterfully, notching a gain of 21.6% from its low over the next three months. After making highs of 352.83 on both Aug. 2 and 3, the index stalled. In fact, the entire month of August was a struggle as RUO shed 5.9% and briefly traded below its 50-day moving average — putting in a low of 331.90 on Aug. 29.

Since that time, however, RUO has firmed up and shown renewed strength. In just the past two weeks, the index has climbed 19.50 points — as of Monday’s close — and now stands a mere 0.4% off its 2005 high.

So what can we look for going forward?

I think that the first technical indicator to look at is the 50-day moving average. Since the Russell 2000 Growth Index broke out above its 50-day moving average in mid-May, that key average has acted as an area of major support. On three separate occasions in the move to its August high — in early June, late June and early July — the 50-day moving average acted as a successful area of support.

And during the August slump, the 50-day average again acted as support — although it temporarily succumbed to the selling pressure on Aug. 28 and 29. Now that RUO has resumed its upward trend of late spring and early summer, the 50-day moving average should contain any short-term backsliding from the index’s recent strength. That average is currently at 341.05 — almost 3% below Monday’s close of 351.40.

Well, should we expect a pullback to occur? For the answer to that question, let’s look at another indicator. In my MST Trader Alert, I use a system of three technical indicators to pinpoint specific trading recommendations — the Slow Stochastics Oscillator, the Relative Strength Index (RSI) and Moving Average Convergence/Divergence (MACD).

The Slow Stochastics Oscillator is an excellent tool to help determine whether an index — or a stock — is in an oversold or overbought condition. I’ll discuss the Slow Stochastics Oscillator in a future “Technical Tuesday”. However, for now, let’s just say that the indicator is plotted with a range from 0-100. An index or stock is considered to be overbought when its Slow Stochastics reading is above 80 and oversold when its reading is below 20.

Right now, RUO’s Slow Stochastics Oscillator is above 95. So according to what the Slow Stochastics is telling us, RUO is in extremely overbought territory. Thus, the Russell 2000 Growth Index is vulnerable to a pullback.

Does this mean that RUO is about to drop like a rock? No, not at all. In fact, an index or a stock trading in a strong uptrend can become overbought — and remain overbought — for quite some time. However, should RUO Slow Stochastics reading drop below 80, it could signal the beginning of a larger retracement.

But it’s important to keep in mind that for now the trend in RUO is bullish. Why do I say that? Four reasons.

First is simply the price action. Since putting in a bottom on Aug. 29, the index has been making higher highs and higher lows. And in that time, the index has recaptured all but a small fraction of the gains lost in August.

Second is the fact that RUO is trading above its 50-day moving average. The 50-day average is a closely watched level of intermediate trends.

The third reason for having a bullish outlook on RUO is that the index is trading above its 200-day moving average. The 200-day moving average — like its 50-day counterpart — is a well-watched price area. The close scrutiny the 200-day moving average receives from traders and investors is a major reason for its significance as a long-term trend indicator. RUO climbed above its 200-day average the same day in mid-May that it reclaimed its 50-day benchmark — and it has stayed above it ever since. The 200-day moving average is currently at 324.79.

The fourth reason I say RUO is in a bullish trend is because of the current configuration of one of the MST Trader Alert indicators I referred to earlier — the MACD. The MACD is the indicator we use in MST Trader Alert to determine whether a stock is in a bullish or bearish trend. It can be used equally well with indexes.

Basically, the MACD is an oscillator that measures two moving averages — either simple or exponential. The difference between those two moving averages is then used to create a third moving average. That third moving average signals whether a trend is bullish or bearish.

Currently, the MACD is signaling that the trend in RUO points higher. MACD flashed a bullish signal on Aug. 31 — and the indicator has been climbing ever since. So I think what we’re looking at right now is a bullish trend that could experience a pullback before a resumption of higher prices. The 2005 highs — just 1.43 points away — are likely to offer some resistance, at least initially. On the downside, any pullback should be limited to the 50-day moving average or — at worst — the August lows.

Small-Cap Indexes: Russell 2000 Value Index

Many of my comments above pertaining to the Russell 2000 Growth Index apply to the Russell 2000 Value Index (RUJ) as well. As was the case with its growth index counterpart, late April marked the beginning of strong gains in RUJ. After bottoming on April 29, and then forming a higher bottom on May 13, RUJ exploded. From its April low to its August high, the index chalked up a nearly 20% gain. Now following a 6.6% slide to a low of 958.55 on Aug. 29, RUJ has taken off once again.

Just as with RUO, the 50-day moving average provided RUJ with a nice level of support during its three-month rally. Once the index conquered its 50-day benchmark in mid-May, the moving average successfully contained pullbacks in late June and early July.

Unlike RUO, however, the 50-day moving average was not reliable in arresting the August decline, as the index spent almost the entire second half below that key intermediate-term level. However, now that RUJ has broken out above its 50-day moving average, that line — currently at 991.25 — is likely to once again act as support. Should that area be breached, the August low of 958.55 should hold as a secondary support level.

The reasons I believe these two areas should be considered support areas are similar to the ones I detailed above when analyzing RUO. The recent price action has carved out a pattern of higher highs coupled with higher lows. Additionally, the index has retaken its 50-day moving average — and remained above its 200-day average as well.Mark Bail
September 13, 2005

Then there’s the MACD. The MACD has been signaling a bullish trend in the Russell 2000 Value Index since the beginning of September. And with the early August high of 1026.28 only 1.9% away, a test of that level should be forthcoming before too long.

However, there is one caution flag out there. Again, as with RUO — the Slow Stochastics Oscillator on RUJ has moved well into overbought territory — above 90. Therefore, I would not be surprised so see a pullback. Should that indicator slide below the 80 level, a decline back to either of the short-term support areas referenced above could be in the offing.

One other point should be made about the Russell 2000 Value Index. Even after the rally of the last two weeks, RUJ is much farther away from its 2005 high than the Russell 2000 Growth Index — 1.9% vs. 0.4%. So — on a relative basis — RUO is presently the stronger of the two indexes. Therefore, given the current configurations of the two indexes’ charts, I’d now cast my vote with growth over value.

The bottom line is this: Both the Russell 2000 Growth and Russell 2000 Value indexes are currently in uptrends. However, they both are overbought and could be vulnerable to some short-term price pressure. But once the overbought natures of both RUO and RUJ are worked off — and the gains of the past two weeks are digested — it is highly likely that both of these indexes will set new 2005 highs. And — barring a significant violation of one of the support levels mentioned earlier — the odds are good that not only will new yearly highs be established in both indexes, but the fourth quarter should provide the astute small-cap trader and investor with some attractive profit opportunities.

Trade well,

Penny Sleuth Contributor

The Penny Sleuth also features commentary by other financial analysts, small-cap experts, investment gurus and an array of contributors from various fields and occupations. Their diverse insights and contrarian investing ideas are hand selected by the Penny Sleuth editors.

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