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It May Be Time to Play Small Ball

This column was originally published on RealMoney on March 27 at 12:00 p.m. EST. It's being republished as a bonus for TheStreet.com readers.

Let's focus on the incremental positives in a market that's been perfect for daytraders but a real pain for everyone else. I know how tough it is to keep your sanity when every rally gets faded and every selloff attracts support. Hopefully this March madness will come to an end soon.

We've been stuck in a long stretch of high noise and low signal. The greatest risk during these choppy periods is to overtrade, because every uptick looks like a bull market and every downtick starts a panic. In reality, not much has happened in the financial markets this month, but things could change quickly in April.

Note the terrible reward/risk profile in the small-caps so far this year. Since the start of February, the iShares Russell 2000 Index Fund (IWM) has risen less than 2 points, although it shows two major selloffs in the same period.

While it's fun to pound the tables about small-caps, disciplined traders would have gotten stopped out of positions multiple times this quarter.

However, the ETF still shows a strongly bullish pattern. Just look at the encouraging progress made in the last two weeks. This is a dynamic setup that predicts increasing upside momentum, with a relatively fast rally into the upper $70s. The next few weeks could be quite positive for the small-caps.

We're all familiar with the underperformance of tech big-caps this year. The Nasdaq 100 Trust (QQQQ) shows a choppy pattern that's offered few rewards to bulls or bears. But look at what's happening just below the surface -- forces unknown are buying the sector aggressively. I suspect that strong hands expect good things to happen in technology during the second quarter.

On balance volume (OBV), which is an accumulation-distribution reading, turned up from its midwinter low earlier this month and now sits at the same level as last January. This is happening while Nasdaq 100 price bars are stuck. This conflict marks a bullish divergence that predicts price will move up and join its counterpart soon.




In turn, this rally might send OBV to a new high for the year and generate yet another bullish divergence. These dynamics would follow the melt-up scenario for a spring rally I discussed last week . But don't bet the store on this outcome just yet. The market has given us so many head fakes recently that this could be yet another false dawn.

The third incremental positive for the current market is that six of the top 10 percentage gainers in Friday's trading were single-digit stocks. It's been well over two years since this particular group has drawn intense and persistent buying interest. That finally appears to be happening again.

This suggests a reawakening of risk-taking by retail participants, which would be a positive development for the broad markets. Low-priced stocks are one of the few corners of the ticker tape not dominated by institutions or hedge funds, so it's a direct read on the activities of small-market players.

This is especially encouraging given the weak performance of junior gold stocks this month. This speculative subsector dominated single-digit gainers through the early part of the year, but a recent correction has left many of these issues treading water.

Source: eSignal Power Scan

Friday's top-gainer list is consistent with single-digit price action in the last few weeks. Small-tech stocks have performed the best over this period, with many beaten-down issues popping out of multimonth basing patterns on strong volume. Here are two good examples.

Amkor Technology (AMKR - Get Report) dropped into a long-term basing pattern between $3 and $7 following a steep 2004 decline. It finally broke above key resistance six weeks ago, rallied to $10 and pulled back to test new support. Last week's strong bounce sets up an important test of the February high.

Glenayre Technologies (GEMS) hit a three-year high in early 2004 and pulled back in a deep correction. It returned to the high midway through 2005, sold off again and bounced back to this level earlier this month. It just broke out on heavy volume, completing a two-year cup-and-handle basing pattern. The target for this rally is long-term resistance above $7.

P.S. from TheStreet.com Editor-in-Chief, Dave Morrow:
It's always been my opinion that it pays to have more -- not fewer -- expert market views and analyses when you're making investing or trading decisions. That's why I recommend you take advantage of our free trial offer to TheStreet.com's RealMoney premium Web site, where you'll get in-depth commentary and money-making strategies from over 50 Wall Street pros, including Jim Cramer. Take my advice -- try it now.

Alan Farley is a professional trader and author of The Master Swing Trader. Farley also runs a Web site called HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback; click here to send him an email. Also, click here to sign up for Farley's premium subscription product The Daily Swing Trade brought to you exclusively by TheStreet.com.

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