Small Cap Stocks: Is the Russell 2000 Looking Bearish?

Mike Turner |

Knowing when to enter a short-biased trade seems to always have a bit more fear and trepidation with it than when on the long side. I know they are just two sides of the same coin. I know that with the right downside strategy (be it option protection or a stop loss setting), there really isn't any difference between taking a position one way or the other.

Oh, I know there are those who believe there is some kind of mystically bad karma associated with betting that the market or a company will move lower so that you can profit from it. That is just silly, of course. But, nonetheless, shorting does carry a bit more risk than being long. After all, in a long position, all you can do is lose everything; if you are short, however, there is no limit on how much you can lose, subject to your downside risk mitigation.

And, I must hasten to add that my comments about the market and any equity is purely theoretical in nature and should not be considered a recommendation to buy or sell any security. I'll even go one step further and say that if you make a buying or selling or shorting decision based solely upon the words in this missive, you will most likely lose money. What I have to say is, indeed, valuable, but should not be taken as professional trading advice. I do not know your financial situation and am not advising you to buy or sell any security.

Having so stipulated that you should not make a trading decision on any opinion stated herein, my analysis of the market, and in particular, the Russell 2000 (IWM), has given me pause to consider shorting the index. Take a look at the chart below:

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This is a "probability" chart of the next 90 days of the Russell 2000. The probability is based on a mathematical algorithm where a cyclical analysis is performed on discrete time cycles of varying frequency and amplitude, that have proven to be consistently in the historical data over 90% of the time in the past. The assumption of this analysis is if the cycles were persistent in the past, there is a high degree of probability that those cycles will exist in the future. The forecast is based on that probability.

As you can see, the probability exists that the Russell 2000 'could' move lower by as much as 13% by mid-June. I am not suggesting you short this ETF, but if the probability proves to be accurate, there is some money to be made on a downside bet.

Another observation should be made... If the 'market-as-defined-by-the-Russell 2000' is going to drop off by 13%, it might be worthwhile to look at any significant unrealized gains and either tighten up the stops or consider taking profits.

Regardless of how you play this probability forecast, it is important that you have an exit strategy for any trade. I always have a downside stop. I happen to prefer stop limits to handle situations such as what occurred this Tuesday when the fake tweet was sent out via AP that the White House had been bombed. The market plummeted for a few minutes before recovering. A stop market would could have been triggered at the low, where as a stop limit would not have triggered until the price recovered. As for picking my stop limit price... I use my Equity Analyzer tool to see what the stop should be, based on the implied volatility of the equity over the upcoming trading week. This trade stop component of this tool is invaluable. It tends to keep my stop just below 'normal' volatility, which gives the trade enough room to bounce within its historical norm without triggering a stop out, yet is high enough to trigger an exit if the trade begins a trend against me.

I am a big believer in having the right tools, rules and strategies. You make the rules, but let the rules make the trades!

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:


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