Small Cap Stocks are in a Trading Range

Small Cap Stocks are in a Trading Range

Posted on August 10, 2021
Ever since the -1.5% outlier day experienced on the S&P 500 index just two weeks ago, the market has lulled itself back to sleep.   Volatility is low and decreasing, heading towards an “extreme low” threshold.  What happens when volatility gets very low?  Well, as we wrote two weeks ago, “When volatility gets low and compressed, it will eventually “pop,” typically down, to relieve some of the pent-up pressure.”  If we do see some sort of “pop” in the form of another outlier day, do not be alarmed.  This a normal event in a low volatility environment. 

Market Breadth
Heading into the mid-July outlier day, we wrote about the Advance-Decline line and market breadth.  Long story short, breadth was flattening out—the market was being led by a few of the larger stocks, while smaller stocks moved sideways or down.  Following the markets “pop”, market participation has increased.  While indexes like the S&P 500 were led to a new high by technology-related securities, value stocks and small stocks had strong weeks as well.  This is a positive sign for markets.  Hopefully, market participation will continue.

Style Indexes
When we refer to the “markets,” the news media and general public are often talking about the S&P 500 or the Dow Jones or Nasdaq 100.  These indexes are not a broad representation of the markets.  In fact, they only represent the US’s largest securities. 

So, when we talk about the strength of the markets this year, how are other indexes, outside of the large-cap securities, doing?  Let’s look at small-cap stocks.  The Russell 2000 represents small-cap securities.  In other words, out the 3000 largest company securities in the US, the Russell 2000 represents the smallest 2000 of those stocks.  That index has moved sideways since February, falling into a trading range:


Russell 2000 ETF, Source: AIQ Trading Expert Pro

You can see in the chart above that following a strong January 2021, the Russell 2000 has fallen in between a point of support and a point of resistance.  Remember, stocks and indexes are driven by the law of supply and demand.  From the chart, you will notice that each time the index has hit that “upper resistance” line, supply takes over.  Each time it falls near “lower support”, demand becomes stronger forcing the index higher.

Supply & Demand
Markets are driven by the actions, emotions, and beliefs of investors.  Why does the stock fall each time it hits support and rise when it hits resistance?  Well, as an analogy, think of it like this: once there is an established level of support and resistance, there is some level of investors psychology.   Each time a security hits that lower support level, there is a wave of demand that comes in. It could be investors hoping to get in at lower price level or the fact that it has risen off of that price level before or any number of factors, but at that price point, there is a wave of demand.  At resistance, there is a wave of supply.  Each time it hits that level, there are sellers of the security.  Again, the psychology could be any number of factors like investors who wanted to get out last time it hit that level and now the opportunity, etc.  The more times a security hits overhead resistance or underneath support, the more significant those lines become.  Eventually, either buyers or sellers will win the battle; either prices will break above resistance or below support. Until then, a security will continue to fluctuate in that “trading range.”
 
Notice that this had nothing to do with the profits and earnings of an individual corporation.  In this example, we showed an index composed of 2000 stocks following the laws of supply & demand.  Each one of those 2000 stocks is going through its own battle between buyers and sellers, summing up to the chart being shown.

Bottom Line
Volatility continues to decrease, approaching extreme low territory.  Remember, even if we do experience an outlier day, do not be alarmed as it is perfectly normal in this type of environment.  Market breadth is picking back up after going through a flat period.  It would be good to see the Advance decline line, which measures market breadth, also put in a new high.

I think it is interesting that the Russell 2000 is in a trading a range.  It really shows the strength of large cap securities.  While we talk about indexes putting in new highs, many stocks are in a trading range and have been moving sideways for the last several months. As we talk about characteristics of supply & demand and why securities fluctuate in patterns, we can keep an eye out for small cap stocks to break above resistance or below support.
 

Canterbury Investment Management: Tom Hardin

More About Tom Hardin

As Chief Investment Officer, Tom has more than 30 years of experience in the investment management industry and has a broad breadth of knowledge. He is known as an innovator, educator and has been revolutionary in the advancements of portfolio and risk management.

 
Canterbury Investment Management: Tom Hardin

More About Brandon Bischof

Brandon is directly responsible for managing the Canterbury Analytics Group (CAG). To date, Canterbury Analytics Group has played an important role in advancing portfolio management from a loose art form based on subjectivity and obsolete assumptions to an adaptive process with scientific rules and methods capable of providing evidence based results and statistically relevant value add results.


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