We’ve been seeing a lot of movement in small-cap stocks recently. The Russel 2000 broke out of a multiyear consolidation pattern and then sold off back to where it started just a few weeks later.
High volatility in small capitalization stocks can be a signal of a market top for several reasons.
First of all, it suggests that risk-on is moving to risk-off. Small caps are high risk/high reward. If investors perceive a bear market coming they will turn defensive and move to blue chip stocks.
It also has to do with profit-taking. At the tops of markets, speculative stocks move high faster as people chase the winners and naive investors are afraid of missing out. There is also liquidity concerns. With a small number of stocks in the float, small caps just move more when people head for the exits.
And lastly, sharp increases in volatility among small-cap stocks often precede broader market declines. While not a definitive signal on its own, high volatility in this segment can be part of a pattern that has often accompanied market tops.
In summary, while high volatility in small-cap stocks is not a foolproof indicator of a market top, it can be a sign that investor sentiment is shifting and that there may be increasing uncertainty or risk aversion in the market. This can serve as a signal that the market might be nearing a peak, which explains rule #47.
Rule #42: Sometimes buying a ticker because it is a good ticker is a good idea. I made a lot of money trading Virgin Galactic Holdings, Inc. (SPCE) for instance, though it is a crap company.
Rule #43: I can be long a company while someone else is short, and we can both make money.
Rule #44: In the back pages of The Economist, you will find the Big Mac index and GDP growth figures. Find the country with the most undervalued currency and the highest GDP growth. Buy it.
Rule #45: Monitor insider buying. Insiders buying at lows means a lot more than insiders selling at highs.
Rule #46: Small-capitalization stocks always lead the way out of a bear market.
Rule #47: High volatility among small caps signals a top in the market.
Rule #48: Vertically moves after a sideways market run as far (up or down)as the sideways chart went horizontal.
Rule #49: Fifty-two-week highs are bullish.
Rule #50: High-volume up-days with no news are bullish.
Rule #51: The best times to buy and sell are at 10:30 a.m. and 3:45 p.m.
Rule #52: It always takes longer than you think for a reaction to occur. And when they happen they go farther than they should.
Rule #53: Use 20% stop-losses on equities and 35% on options.
Rule #54: Trend lines work better than support and resistance.
Rule #55: The market is always right.
All the best,
Christian DeHaemer
Chief Financial Analyst
Outsider Club
