The small caps have been underperforming the other indexes for quite some time. Even when they made the new high, IWM iShares Russell 2000 Index (ETF) was down some 12% before it started rallying to make the new highs.

So why is it dangerous to be shorting the Russell 2000, since it continues to underperform? Because the footprint for an actual top is not there —yet! Does that mean new highs are coming? I have no idea, they may or they may not. But ask yourself, even if a top is in place and the next major low for IWM isn’t coming until it touches the 97 area, would you hold the short position if IWM bounces to 118-119 from the current 112.60 level?

What I am saying is that the footprint for the actual top comes in a rounded top pattern. Typically a test of the highs (hi-low-retrace) that retraces 50% minimum and 78% or even 100% is what takes place before one can comfortably say an intermediate term top is in place.

Why is that important now? Because since IWM made the 121 high on July 1, 2014, it has only managed to retrace 38% of the drop with each bounce. From a historical perspective, that is not enough of a bounce to say the highs have been tested and failed.

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Looking Back At History

Since the 2009 lows, IWM has only seen this type of drop without a test of the highs (minimum 50%) once. That was in January 2014. Once those lows were in place, IWM rallied to make new all-time highs. 

Buying Spot Ahead?

There is a chance IWM makes it down to the 110.60 area, but I think looking at that as a buying opportunity for the bounce to 118ish, has very good odds of paying off.

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