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After the Bounce: Turn Investing Focus Toward Demand


The Russell 2000 may experience daily hiccups, but checking out longer-term trends shows the bigger picture.

With the recent price depreciation in the US markets, there's a tendency to get microscopic with analysis when a more macro view is warranted. A chart of the Russell 2000 (INDEXRUSSELL:RUT) shows a complete breakdown on the daily chart, but even here the test came into a wide price-spread bar, where it found temporary support.

The usual scenario is for some sort of fast first move when a range is broken, followed by a bounce that retests and attempts to regenerate lower.

However, if we pull the Russell 2000 chart back to a yearly view, it still looks quite healthy.

The present worries are but a minor aberration in the longer-term uptrend. We've seen them before (in May of last year, then again in August), and we'll see them this year. A longer-term investor shouldn't be concerned about a minor hiccup unless it has the potential to become something much more. Knowing that the real damage is done on failed bounces off the first pullback, it's always the bounce that a longer-term investor has to be concerned with. That investor also has to concentrate most on the demand exhibited from that bounce. Is the bounce strong or weak when it gets to the supply line, and does it chew away at supply? That supply line on the Russell runs from around $116.50 to $118.

There's another critical factor that should be considered: attempting to measure just how far a pullback can carry. To do this, one should analyze the structure that has formed underneath current prices. If there are clustered swing-point lows -- as there are on the Russell and other indexes as well -- a crack in those levels could easily lead to faster selling. That selling could really do some damage to most stocks if it were to occur, because the potential percentage losses on the intermediate-term time frame are much larger than those on the daily time frame.

Another question to pose: Is leadership being sold? The answer to that is that it most certainly has been. Leadership stocks have taken huge hits relative to most stocks. Many have declined 10% to 20% in a relatively short period of time. Unless something steps up to take their place, or unless they begin to lead again, the market struggles will continue. Right now, that looks likely. First a bounce, then more struggles. In the current market, the main concern is not this first draft down but a failed bounce that leads to further selling and eventually threatens the lower swing-point lows. That's where the more damaging selling will come from. That's where the focus needs to be.

Editor's note: L.A. Little is a professional trader, author, and money manager who has written several books and contributed material to many financial sites in addition to authoring his own: Technical Analysis Today. He brings a unique perspective to technical analysis, incorporating his extensive engineering and modeling skills when analyzing the markets.

Twitter: @tatoday
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Little has a position in TZA.
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