Keep an Eye on the Russell 2000

My job in tracking retracement patterns for the short term is made considerably tougher in real time because it is almost impossible to know ahead of time which index holds the key for a particular move.

If I knew in advance that it's the Dow or the S&P 500 that I should be paying closest attention to, the next trade would be a snap. Problem is, sometimes I am glued to the S&P and I should be following the Dow, Nasdaq 100, or maybe even the Russell 2000 for guidance. That was the case yesterday, at least for the short term where you try to sell at the top of the move -- in particular, the top of a gap -- betting on a hairpin turn.

It didn't quite happen in the SPX or S&P futures -- the gaps from last Thursday, at 1057 and 1053 respectively, were exceeded by 3½ points in both cases. Now for those who view things from a broader perspective, that may be fine. But when you trade options and futures, these little overruns can be a big deal. It's like looking at an anthill from a distance vs. looking at an ant through a microscope -- I am looking through a microscope all day long.

Yesterday's pop above the Oct. 1 gaps in the S&P threw me off for a moment, until I noticed that the Oct. 1 gap in the Russell 2000 hadn't quite been filled. That gap was at 604.28, and yesterday's rally stalled two-thirds of a point shy. From there the RUT sold off to the 595 level and the S&P pulled back 14 points back to the morning lows, in the futures scoring a perfect double bottom with the morning lows at 1042.50. Pretty tradable, if you are looking through a microscope.

Russell 2000 (RUT) Stalling at the top of the October 1 gap OptionsXpress

The moral of the story is that at least for now, we should continue to pay close attention to the Russell 2000 and especially to the top of that gap at 604.28. A move above it by more than a couple of points would likely bring further upside, possibly back up to challenge the recent recovery highs at the 625 level. From there, a move above that level could lead to a challenge of the important support-now-resistance at the 647-650 level. That area will no doubt give the market plenty to chew on, if it gets back up there.

Granted, this approach isn't for everyone. Many "investors" will say, "What a lot of nonsense! Why not just buy 'good stocks' and hold them?" Funny, I used to hear that GM was a "good stock" ... guess it's not anymore. Remember, though, I don't have a crystal ball. Just a roadmap, which is better than nothing.

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At the time of publication, Schiller was long mutual funds up to 20% levels, bullish (put) credit spreads in the Russell 2000 and SPY options, although holdings can change at any time.

Dr. Harry Schiller is a Registered Investment Advisor with the California Dept. of Corporations. He holds a Series 7 General Securities license as well as a Series 4 Options Principal license. He has been owner and editor of the Short Term Consensus Hotline since 1988. For more information, see www.harryschiller.com. Under no circumstances does the information in this commentary represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.