MAILBAG QUESTION:

"you wrote the other day that there could be big upside potential in the russell, but smaller companies in it aren't as much in favor as they were. why bullish now?"

MY RESPONSE:

The Russell 2000 (RUT), which has been in a broad sideways trading range for the past 12 months, after a strong 2012-2013 advance, may again have further substantial upside potential. There are potentially bullish patterns seen on both a daily chart and, on a longer-term weekly chart basis.

The weekly chart can be seen either as a past 12-month sideways consolidation trend (a 'rectangle'). Or, the weekly chart is alternatively interpreted as a sizable Head and Shoulder's bottom formation. Such H&S bottom patterns can be relatively easy to spot and quite profitable if you trade based on the implied upside move that such patterns tend to forecast.

I'll let my chart highlights do a lot of the 'talking' here as I note bullish interpretations on the RUT daily and weekly charts.

RUSSELL 2000 (RUT) DAILY CHART:

My first chart is one seen in my Index Wrap written on Saturday (2/14/15) but with some added technical analysis. I did mention previously that RUT has traced out on a daily chart basis, a bullish symmetrical triangle. This consists of two down-sloping trendlines that have the same slope (hence, the symmetrical shape). When the trendlines are extended out into the future, they converge.

A breakout move above or below such a triangle pattern will tend to result in a strong further move in the direction of the breakout, in this case UP. Note the 'classic' trendline aspect of a down trendline first 'acting as' resistance; but, after piercing this trendline to the upside, the trendline becomes subsequent support. This is a sort of 'proof' that the Index or stock in question is going higher. How much higher?

A rule of thumb on potential for such an upside breakout is that the earlier WIDEST distance between the two trendlines will equal a next upside objective when that same point distance (82 here) is ADDED to the breakout point per my illustration; i.e., suggesting a possible advance to 1278. Stay tuned on that!

RUSSELL 2000 (RUT) WEEKLY CHARTS:

The most bullish chart interpretation, but not the only one, is seen on the weekly chart up next. I've illustrated this first weekly chart as having traced out a broad Head & Shoulder's bottom. What does an H&S bottom look like? Basically, it looks like the reverse of an H&S top pattern.

SHAPE: There's a three-trough formation with the center trough below the other two lows that precede and follow the lowest low in the center. The left and right 'shoulders' should be opposite one another about the head and somewhat equidistant in both time and price. There are some variations but the formation is usually noticeably symmetrical about the head.

A line that connects the top end of the two shoulders is the so-called 'neckline'. A piercing of the neckline 'signals' an upside breakout. One classic rule of thumb for the resulting upside potential is noted on my chart. First is to measure the distance between the neckline and the bottom of the head. Add this distance to the breakout point above the neckline on the right shoulder. This measurement results in a potential objective to 1376 over time.

There looks to be substantial upside potential. A 20 to 30 percent rise after the breakout (above the neckline) has often been seen with stocks that develop this pattern, assuming a good number of these outcomes are studied.

I'd also note how the 13-week Relative Strength Index got to an oversold extreme at the early-October bottom, which was a good tip off to a high potential trade in RUT calls.

Another, simpler way to evaluate the RUT weekly chart is to just view RUT's 12-month prior price action as that of a sideways consolidation relative to the prior major 2-year advance. Labeling the past year as forming a 'base' pattern is also known as a rectangle formation; a 'rectangle' was Charles Dow's term.

The lowest low, noted as the 'V-bottom' below, is not the low point of the way I've drawn the low end of the box, but the two lowest (intraweek) lows were short-lived. Only ONE weekly Close was below 1085 so a fair depiction of the low end of the dominant price range is as shown.

Multiple highs just above 1200 'defined' the UPPER end of RUT's 12-month broad trading range (rectangle) pattern. This past week's Close looks like the beginning of what could be a decisive upside penetration of the upper 1218 line of resistance.

If a bull move above 1200 continues and I think it will, a projection of an upside objective is simply to add the prior dominant price range (133 points) TO the top (resistance) end of the rectangle, resulting in a target to the 1350 area.

The aforementioned analysis of a potential upside objective, while a more modest assessment than the Head & Shoulder's calculation, ALSO suggests substantial upside potential for the Russell. The charts to me suggest that RUT stocks will come back into favor.


GOOD TRADING SUCCESS!