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Now This Is a Strange Small-Cap Reading

If I calculate the daily net change between the 50-day and 200-day moving averages for small caps I find an oddity. Let me explain.

The Market

I have been keeping statistics on the market for nearly 40 years, and this week I have come across one of the strangest oddities in a small-cap indicator.

I do not like to rationalize an indicator, so I won’t, but my sense is the reason this particular indicator is so odd is the nature of the 30% decline last year in March, coupled with the high level of the Russell 2000.

The indicator has to do with the small caps. What I do is I calculate the daily net change between the 50-day and 200-day moving averages. So, it is not how many points the spread is, but rather how many points the spread gained or lost on the day.

One thing has remained constant in the 30 years I have been tracking this: The daily net change goes negative when the Russell sells off hard. Generally speaking, it is because the 200-day moving average line moves so much more slowly than the 50 day. So, in a fast moving market that is heading down, the 200 will still be rising while the 50 day is either flat or heading down.

The thinking is that when that daily change gets extreme, we’re getting oversold, because things have moved too far, too fast. Here is the chart, with some notations. I have taken it back 20 years.

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Now let’s look at the same time frame for Russell 2000 fund (IWM) - Get Free Report.

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Point A arrived late July 2002. The Russell had fallen about 30% pretty much in a straight line. It rallied and then came down again into the ultimate low in October of that year.

OK, makes sense, right? Too far, too fast.

Point B was late November 2008. I don’t even need to do the math for you, because you can see the collapse. We rallied and came down again into the March low. Again, makes sense as it had gone too far, too fast.

Point C was the "Flash Crash" of 2010. That was only 10%, but again, it happened so quickly, so it makes some sense. That low was retested in August of that year.

Point D was the big whack in August 2011. That was 20%, again in a hurry. We rallied and came down again into the October low.

Points E & F could have been point E alone, but I thought they looked a bit more distinct on the chart, because they show up as twin lows on the indicator chart (the others do not, they show up as oversold on the first low). Point E is summer 2015, when we collapsed in late August. That was good for 10% quickly. We rallied and came down again in January of 2016. By the time that January 2016 low came around, the Russell was down nearly 20% from the high.

Point G is the fourth quarter of 2018’s decline. The low on the indicator chart is in early December; the low was late December. That was 30% in three months. Point H is one we all know by now, since that was March of last year. There was no retest at all last year. That changed the pattern of a rally and back down.

But that brings us to the current reading on the indicator chart, that is fast approaching last year’s March reading. Part of it is the math, because higher numbers (levels) create bigger numbers, but the swiftness of the decline for that indicator is something to behold considering the Russell’s decline this time was 10%, but that was a month ago. In late March, when the Russell had fallen 10%, this indicator was still at the zero-line. One thing that was consistent with all the prior instances is that you can see the declines on the chart, and you can see them readily, there is no guessing. This time you can’t even see it on the chart. Again, it’s likely the math but keep in mind the math is because the 50-day moving average has been so flat, while the 200 day is still rising.

They are catching up to each other.

The bottom line is, this indicator has been bullish in the past when it has come down this far. The set up is vastly different than the prior periods, though. If the Russell rallies strongly from here, will it be like all the prior instances (except last year), where this was the initial rally and then it came back down?

As for last week, it was mostly all the down-and-out speculative stuff that rallied and that helped breadth. We saw that good breadth Wednesday, also during Thursday’s decline and again on Friday. This is a big earnings week, and I don’t like to play earnings, but if any of those big-cap index movers rally on their earnings, the indexes will move up. I would have preferred more work on the downside.

New Ideas

I was asked about Adobe (ADBE:Nasdaq) in March, when it was near its lows and the only thing positive I could come up with on the chart was that it had broken down and if it could recapture the breakdown level ($460-ish), it might be OK. I really had thought that it would take an awful lot for it to eat through that resistance, but I was wrong, as it powered through like a hot knife through butter. Now it has come back to retest the breakout, so as long as it can stay over that $500 area, there will be trouble at the old high near $535, but no one even talks about liking tech anymore.

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Today’s Indicator

The new lows have contracted, which is a positive, but new highs are still not expanding, which is a negative.

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Q&A/Reader’s Feedback

Helene welcomes your questions about Top Stocks and her charting strategy and techniques. Please send an email directly to Helene with your questions. However, please remember that TheStreet.com Top Stocks is not intended to provide personalized investment advice. Email Helene here.

Is the chart of Penn National Gaming (PENN:Nasdaq) going to turn out like Adobe above? By that I mean will this breakdown matter, or will we see it rally and recapture that $100 area readily? It will need to recapture $100 easily, because if it doesn’t, then the measured target is near $70.

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Zoom (ZM:Nasdaq) has sucked me in several times as it keeps looking as if it is rounding under and wants to rally again only just as it gets going it dies one more time. If it can get through $350, then $375 comes into play so the risk/reward is pretty good here, because a move back under $325, and I know I’m wrong.

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The Global X Genomics & Biotechnology exchange-traded fund (GNOM:Nasdaq) looks quite similar to the IBB biotech fund (IBB:Nasdaq) I recommended here a few weeks ago. This needs to clear $24 or so to make me believe it has really improved.

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Sirius XM Holdings (SIRI:Nasdaq) has earnings this week, and I hate to get in front of earnings. The chart looks like a toss up to me. By that I mean through around $6.50 and $6.80 is probably doable, but under $6.25 and $6 is the target. So I will call it a trading range between $6 and $7.

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Peloton (PTON:Nasdaq) looks like a head-and-shoulders top. But it refuses to break. We have seen so many charts like this that threaten to break and then get saved or they break and then they just hang below the breakout before they recapture it. If you want to speculate in this on the long side, then the risk/reward isn’t bad, because you know you’re wrong if it breaks under around $99. If it breaks the measured target would be all the way back in the $40s. Earnings are out in early May.

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I was asked to take another look at iShares China Large-Cap (FXI) - Get Free Report an exchange-traded fund for the Chinese market. You might recall I was a bit non-plussed with this chart when we looked and instead I suggested the emerging markets ETF, EEM (EEM) - Get Free Report, which I still like and think should move higher. However, FXI did cross that small downtrend line on Friday, which probably takes it out of the woods. There is still plenty of resistance overhead, but at least now we know it’s improved and I’ll say I am wrong to like it if it breaks $46.

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