ETF Trade SPY: Russell 2000 Nearing Danger Zone

The Russell 2000 is one of the top performing indexes this year. It outperformed most broad market and sector indexes, but is nearing resistance that’s kept a lid on every advance. Here’s how to tell if the R2k is ready to top out.

“Are we there yet?” If you are a parent you’ve no doubt heard this question.

Kids can be impatient and don’t read maps or GPSs, so the question makes sense.

Investors often ask themselves a similar question. Instead of “are we there yet?” they ask, “how much up side potential is there?” or is the stock ‘there’ (at its peak) yet.

The closest thing to a GPS for stocks are trend lines. Trend lines outline the path for stocks, indexes or ETFs.

The chart below shows a parallel channel for the Russell 2000 Index (Chicago Options: ^RUT).

At first glance it looks like the Russell is ‘getting there’ or approaching a possible top.

Like a tenacious woodpecker, the Russell 2000 keeps chipping away at parallel channel resistance without out actually penetrating.

This hasn’t hurt performance. Since the channel is ascending, the Russell 2000 can continue higher without ever breaking above the channel. But we see that almost every touch of the upper channel line (red circles) caused a temporary pullback.

The rally from the November 2012 and June 2013 low has been very steep and with all things that are too good to be true, the Russell will eventually give back some (or most?) of its gains.

RSI (gray circle) is already showing signs of fatigue. Although this is a small warning signal, RSI can lag for months and RSI-based sellers may miss a big portion of a rally.

The chart for the iShares Russell 2000 ETF (NYSEArca: IWM) and Vanguard Small Cap ETF (NYSEArca: VB), although not as crisp and clean, look very similar to the R2K index.

Since the Russell 2000 has outperformed the S&P 500 (SNP: ^GSPC) to the up side, it will probably outperform the S&P 500 to the down side. Now don’t go out and short the R2K or S&P right now, but you may mentally prepare for a possible shift from an up to down trend.

How To Spot a Top

Stretched rallies have a tendency to flame out with a trend channel over throw, where prices stage one last hurrah and spike above the channel. A close back below the channel often concludes the rally and kicks off a prolonged decline.

Any decline has to be confirmed by a drop below resistance, which didn’t happen in April and June (green circles).

The ETF Trade SPY is a free weekly feature that identifies ETFs near major inflection points created by support or resistance levels.

Prices near support/resistance levels tend to be great setups for low-risk trades. Why low-risk? Support/resistance is used as stop-loss and is an effective risk management tool.

If you only enter trades where your potential gain is bigger than your potential loss, you win.

To receive future issues of the free ETF SPY follow iSPYETF on Twitter @ iSPYETF.

ETF SPY History

XLK: July 24, 2013, ETF SPY predicted higher prices for XLK. Click here for XLK support and target levels.

Dow Theory: July 19, 2013 ETF SPY predicted higher prices for Dow Jones Industrial and Dow Jones Transportation Averages.

XLF: July 12, 2013 ETF SPY predicted higher prices for XLF along with a price target.

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Weekly ETF SPY: SPY ETF vs S&P 500 – Technical Analysis Variations

The S&P 500 Index triggered a beautiful ‘kiss good bye’ signal on Tuesday, before Bernanke spoke and sunk stocks. Interestingly, the sell signal for the S&P 500 could not be seen in the chart of the SPDR S&P 500 ETF (SPY).

SPY S&P 500 ETF or S&P 500 Index. What’s the difference? It’s like tomato or tomato (imagine the second ‘tomato’ spoken with a British accent).

I always try to base my analysis on the purest representation of any given index or asset class. When it comes to the S&P 500, the purest representation is the actual S&P 500 Index you always see quoted.

The SPDR S&P 500 ETF (SPY) tracks the S&P 500 very closely, but even minor variations can make a major difference.

For example: The June 18 Profit Radar Report (released the night before Bernanke opened his mouth and buried the market) noted that the S&P 500 is at an important inflection point and warned:

There is a parallel channel going back to the October 2011 low. Indexes often touch a previously broken support (in this case the black October 2011 parallel channel at 1,655) before dropping to a new low. The S&P touched this channel today and failure to move above could spell trouble.

The first chart below shows the S&P 500 parallel channel referred to in the Profit Radar Report (if you aren’t a subscriber, I tweeted a close up picture of this channel on Tuesday).

I have often observed the S&P 500 (and other indexes) double back a broken support before letting go and peeling away for good. This upper line of the parallel channel was a key ingredient to the bearish forecast (the recommendation of the Profit Radar Report was to go short at S&P 1,635 and Nasdaq-100 2,970). I call it the ‘kiss good bye.’

Drawn in the second chart is the exact same parallel channel for the SPDR S&P 500 ETF (SPY). However, unlike the S&P 500 Index, SPY’s channel is placed differently. There was no kiss good bye for the SPY ETF.

Key support (red line) was broken for both, when prices dropped below the June 6 low (160.25 for SPY and 1,598.23 for the S&P 500).

The SPY chart allows us to draw a support trend line (green line) that’s unique to SPY. I wouldn’t say there is a clear winner in the SPY vs S&P 500 debate, but I prefer to base my S&P 500 technical analysis on the S&P 500 chart. It’s as pure as it gets.

Why further down side is still ahead, what the down side is, and why stocks will rally again when this is all over is discussed in Thursday’s special Profit Radar Report.

Federal Reserve – How to Tame the Monster it Created

Thanks to quantitative easing (QE) stocks are up 130% and more. The Fed created a monster of a rally, but how do you tame the monster without killing it? As the most recent Fed minutes indicated, it may be ‘easier’ than some think.

Never under estimate the psychological power of a dangling carrot. For years the Federal Reserve used the promise of more QE as an incentive (carrot) to drive stocks higher.

This has worked well. Too well. The Dow Jones, Russell 2000 and other major indexes are trading at all time highs and the Fed’s next challenge is to tame the monster (rally) it created without killing it.

How can this be done? Perhaps with the ‘reverse dangling carrot approach.’ Before we talk about the reverse carrot approach, let’s review how the ‘dangling carrot approach’ works.

The ‘Dangling Carrot Approach’

At how many post FOMC meeting conferences did we hear Ben Bernanke assure Wall Street that the Federal Reserve is ready and willing to assist?

From July – November 2010 Bernanke’s steady assurance was nearly as potent as QE2. Do you remember the August 2010 Jackson Hole summit? Bernanke then said: “I believe that additional purchases of longer-term securities … would be effective in further easing financial conditions.”

The placebo QE effect was strong enough to lift the S&P 18% before QE2 became official on November 2, 2011. Thereafter the S&P 500 rallied another 16% to the April 2011 high. QE2 ended in June 2011.

From October 2011 – September 2012 the Fed did nothing more than dangle the QE3 hopium carrot and the S&P 500 rallied 36%. QE3 was finally announced in September 2012, followed by “QE4” (replacement of Operation Twist by outright Treasury purchases).

Containing The Fed Monster – The ‘Reverse Dangling Carrot Approach’

From 2009 – 2012 the Fed talked up QE and stocks. Today the S&P 500 trades 135% above its 2009 low and the Fed knows it created a monster (rally). The Fed also knows that everyone else knows this is a phony funny money rally.

How can the Fed contain the monster it created – take away the punchbowl without causing a severe hangover. The ‘reverse dangling carrot approach’ is born.

Dropping hints about more QE contained the bear market, so dropping hints about reducing QE should tame the QE bull market. This process may have already begun.

The release of the Fed minutes on February 20, showed dissention among committee members about the duration and scope of QE.

Whether this division over the issue is real or just a new PR strategy to contain the Fed monster, I do not know. But we do know that stocks sold off right after the Fed minutes were released.

Just like controlled fires can stimulate a forest, the Fed may try to light ‘controlled burns’ to manage the stock market. As in nature, the summer time (starting in May) is a good time for a ‘controlled burn’ on Wall Street. Shareholders should plan accordingly.

I personally view the Fed like an unwelcome guest. Some guests bring happiness wherever they go. Some (like the Fed), whenever they go. Unfortunately, the Fed’s comment about leaving (scaling back QE) appear to be only a tease.