Market Rotation Into Small caps is unfolding.
IWM ETF appears to be set to make another rally here to the upside as the market rotation into small caps continues. Russell 2000 (IWM) pulled back late last week and is now bouncing off of the Fibonacci retracement levels and sets up for a potential rally higher from here. On Monday, IWM, which is the ETF for the Russell 2000 had pulled back to the 38.2% Fibonacci, as well as its anchored VWAP (volume weighted average price) that was set to its recent lows prior to the initial rally that started on July 11th. Here’s the video where I outline the trade setup:
Now, it is important to understand market rotation, particularly as it concerns swing trading, because rotating with the flows of capital is essential to being in the right place at the right time with your portfolio.
Market rotation in swing trading is all about the movement of money between different areas of the stock market as conditions change. In my case, I am following the market rotation into small caps from large caps, which is a little different than sector rotation which is the flow of one sector into another like technology into industrials. Of course there are plenty of rotations on both a micro level and onto a macro level. At one point last week, and we may still see it unfold some more, where money has flowed from growth stocks and into value plays. Understanding this process can help traders anticipate potential opportunities and risks.
Right now, you have money moving out of the large-cap technology stocks, like Nvidia (NVDA), Apple (AAPL) and Microsoft (MSFT) and now we are seeing much greater and increased interest in small-cap stocks across almost every sector (minus technology). One of the main reasons for this market rotation into small caps revolves around valuation concerns, and the possibility that Wall Street has squeezed out as much as it can from tech, and now it is looking for some fresh turf. IWM on the other hand has hardly seen any interest from the Street since late 2021.
With the potential for interest rate cuts as soon as September, this could also help increase speculation that it will benefit the small cap stocks more than large caps. And it may not even be that people are completely selling out of tech, but with the outlandish gains from 2023 & 24, they may be looking to add more exposure into small caps in order to help diversify their holdings by cutting down their exposure in technology stocks.
As a result, going forward, don’t be surprised if you see much of the exact opposite of what you saw throughout this year where most rallies favored the Nasdaq 100 at the expense of the Russell 2000 as the market rotation into small caps unfolds. With small cap rotations, the price action can be much more volatile than what you would likely see with a rotation into value plays or large cap stocks. Individual stock selection can have all sorts of problems from a lack of liquidity, and the potential for headline risk that can tank a stock’s share price. That is one of the reasons, why I prefer to trade more of the small cap ETFs than the individual stocks. And of course, the risk lies in the potential for the rally to be short lived. Earnings season is starting up here and if the mega cap plays, particularly Microsoft (MSFT), Apple (AAPL) and Nvidia (NVDA) beat expectations handedly, it could quickly stall out the strength and momentum that has been seen in small caps.
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Hope to see you in there!
