3 Trading Ideas for Small-Cap Bears
3 Trading Ideas for Small-Cap Bears
U.S. small-cap stocks received substantial inflows of cash between May and September 2018 as investors saw them as less immune to geopolitical tensions, trade tariffs and a stronger U.S. dollar. Small- and mid-cap companies were also primary beneficiaries of President Trump’s tax reform plan that reduced the corporate tax rate from 35% to 21%.
During the past month, however, small-cap stocks have suffered roughly double the losses of their large-cap counterparts. As of Oct. 22, 2018, the Russell 2000 Index, which tracks the performance of 2,000 U.S. small-cap companies, is down 9.45%, while the S&P 500 Index, a broad proxy for large-cap stocks, is down 4.82%. From a technical perspective, the Russell 2000 is now trading below both its 200-day simple moving average (SMA) and multi-year trendline.
Traders who believe small-cap stocks have further downside ahead should consider using one of these three inverse exchange-traded funds (ETFs) to bet against the Russell 2000 Index. Let’s look at several trading opportunities.
Direxion Daily Small Cap Bear 3X ETF (TZA)
The Direxion Daily Small Cap Bear 3X ETF, launched in 2008, seeks to provide three times the inverse
daily performance of the Russell 2000 Index. Average daily trading volume (ADTV) of $106.46 million
and an expense ratio of 0.96% make this ETF a suitable choice for traders who wish to take an aggressive
short-term bet against the Russell 2000. TZA’s price broke above both the eight-month downtrend line
and 200-day SMA in early October on above-average volume, suggesting further upside momentum. The ETF is currently forming a pennant,
which is a continuation pattern, that is finding support at the 200-day SMA. Traders who open a long
position on a break above the pennant’s upper trendline at $11 should protect it with a stop-loss order
just below the pattern’s low. A profit target could be placed at $13.5 using the measured move technique.
Traders do this by calculating the distance of the move leading into the pennant and adding it to the pattern’s breakout point ($2.5 + $11).
Chart depicting share price of the Direxion Daily Small Cap Bear 3X ETF (TZA)
ProShares UltraShort Russell2000 ETF (TWM)
Formed in January 2007, the ProShares UltraShort Russell2000 ETF aims to return two times the inverse
daily performance of the Russell 2000 Index. Although TWM’s ADTV of $14.07 million is less than that
of TZA, there’s still sufficient liquidity for short-term traders who believe that the Russell 2000 will
continue falling. The fund charges a 0.95% management fee. Like TZA, TWM has enjoyed an early October surge on strong volume as small-cap stocks came under intense selling pressure. Traders should look for an entry point on a breakout above the pennant pattern’s upper trendline at $16.5, with a stop sitting slightly below the 200-day SMA. Profits could be taken at the $18.75 level using the measured move method ($2.25 + $16.5).
Chart depicting share price of the ProShares UltraShort Russell2000 ETF (TWM)
ProShares Short Russell2000 ETF (RWM)
Created in 2007, the ProShares Short Russell2000 ETF attempts to provide the inverse one-day performance of the Russell 2000 Index. It achieves its objective through the use of ETF and index swaps. The fund charges an annual management fee of 0.95%, less than the 1.02% category average, and has ADTV of $21.84 million.
As RWM tracks the Russell 2000 Index, its chart is similar to the first two ETFs discussed, although the pennant pattern’s low point sits above the 200-day SMA, not on it. Traders may choose to place a buy stop-limit order just above the pennant’s upper trendline at $41.5 and bank profits at $44.75 ($3.25 + $41.5). A stop-loss order could sit below the Oct. 16 low to close the trade should the price move in the opposite direction.
Chart depicting share price of the ProShares Short Russell2000 ETF (RWM)