Small caps lead the way?

Last week I wrote a newsletter focusing on the key levels for the S&P and Dow that we would need to watch in order to get a sign of the next move in the overall stock market. For review, please go to http://www.themeshreport.com/2010/11/where-are-we-going/ The resistance level on the Dow seems to be around 11,200 – 250 and the corresponding resistance for the S&P is around 1200.  Although earlier this week it appeared that support might be breaking instead, the markets have rebounded nicely today.

Please look at the current position of the S&P and Dow below:

You can see the resistance levels above and also the brief break of support on the Dow. However, the S&P did hold support and both indices have now rallied back up to resistance. So, can we break higher?

Maybe small cap stocks, as measured by the Russell 2000, can give us a potential hint? Please review the chart of the Russell below:

The Russell seems to be breaking higher today. If the Russell can hold its gains, and even move higher, it could be a sign that the larger caps will follow. When investors are in the mood for risk, it is not uncommon for the Russell to reflect that mood. Small cap stocks tend to be the riskier plays, thus the potential for greater gains.

The Tale of the Tape: Seeing the Russell break higher today should be a sign that the Dow and S&P will follow, but I would urge caution until that actually happens. Remember, the Russell isn’t going anywhere without the “big boys”. If the broader market can confirm the Russell’s breakout, this should provide an excellent opportunity to enter various long positions as long as the breakout holds.

No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.  Capital preservation is always key!

Good luck!

Christian Tharp, CMT