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What Does the Elliott Wave Theory Say About Small Cap Stocks?


After a typical Fibonacci retracement from October through March, here's where we are in the cycle.

The IWM ETF represents the Russell 2000 small cap growth index. This ETF peaked at 84.66 this spring and has fallen in 74s before the recent two-day bounce. What we are looking at is a possible 5 wave rally from October into March, and now a possible 3 wave correction (Wave 2) of 38% - 50% of that entire 5 wave rally. Elliott Wave Theory is broken down into 5 wave and 3 wave movements in the markets and individual stocks, where a full 5 wave pattern in a bull market is obviously bullish and a 3 wave pattern is corrective of the prior 5 wave rally.

The small cap index peaked with the reset of the market in March of this year, interestingly about three years into the bull market. The first low so far was a typical 38% Fibonacci retracement of the rally from October through early March. The next low pivot would be a 50% pullback. This would place the IWM target around 72.10 plus or minus some pennies.

In the 72s, that would represent a C wave decline that is equivalent to 161% of the A wave decline in the chart below from the 84.66 highs. ABC declines are common in a bull cycle and are designed to throw investors off the back of the bull. Normally the C wave is where investors finally throw in the towel near the bottom, as we saw in early October 2011. I wrote an article on October 3, 2011 last year (see Are Silver and Copper Prices Predicting a Global Recession?), one day before the bottom, outlining the reasons why a massive rally was about to ensue. Will we see the same thing now?

Well, this correction could indicate one more possible decline of 4% - 5% in the worst case should this projection in the chart below be fulfilled.

That said, the 38% retracement we have had so far would also qualify as a Wave 2 low last Friday. Therefore, this outline is to give you some indications of what to watch in case we drop further and pierce those lows. If we can hold this rally and rebound smartly again, then the C wave of the ABC is likely over and we can get an all clear to be more aggressive.

Click to enlarge

Editor's Note: David Banister is the chief investment strategist and co-founder of, a small-cap portfolio and market advisory service.

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No positions in stocks mentioned.

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