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Small-Cap Monday - Here's 3 More Tips for Your Trading Arsenal

By Bill Spencer August 31, 2020 Facebook Logo Twitter Logo Email Logo LinkedIn Logo

Hi there...

Happy Monday. Thanks for stopping by.

During the run up to Labor Day, I'm going to give you some tips on making your trading labors much easier.

Today's conversation picks up where the one from June 27th left off.

Back then, in a column called Here's Your New Favorite Trading Tool (Part 1) I wrote...

"Checklists make everything easier to do well. "Here are some things that, if you attend to them, will make trading much easier."

Our first three items were...

  1. Always start by looking at the wider market.
  2. Keep and maintain a stock watchlist.
  3. Be on the lookout for "crosses".

Today, we'll add the next three more "to dos" to the list.

First, let's see how the market's been doing.

(Click any image to enlarge)

All five major averages posted gains. And for the second straight week, small-caps trailed on a relative strength basis.

The tech-heavy Nasdaq Composite again took top spot, gaining an impressive +3.39%. The S&P 500 added +3.26% while the Dow Jones -- one week before undergoing a major shakeup -- caked on +2.59%.

Our two small-cap proxies -- the Russell 2000 (RUT) and the S&P 600 -- rose +1.93% and +1.66%, respectively.

Before we get to the checklist, I'd like to clarify something from last week's Small-Cap Monday.

I had said that small-cap stocks were underperforming across all sizes and styles (small-cap growth... small-cap blend, etc.).

Then I offered five small-caps that were underperforming both the market and their sector peers. (Their sectors were also underperforming the market.)

Based on your comments, it's clear I gave the impression I was bearish on the market. I'm not.

This is our #1 indicator/risk barometer -- the New York Stock Exchange Bullish Percent Index (NYSE BPI).

This chart shows us the percentage of stocks trading on the NYSE that are currently on point-and-figure (P&F) "Buy" signals. (This view of the NYSE BPI is in point-and-figure style.)

The chart is on a Buy signal. The most recent O-column (on the right side of the chart) never fell below the previous O-column.

The chart is in a column of Xs, meaning that the market is strong over the short term.

Finally, at 62.57, the chart has yet to reach the 70 overbought level. Once it reaches 70, bullish traders will face elevated risk. That's because most of the capital that drove the market higher has been spent.

There's not much available to drive prices higher. Plus, profit takers will sell, and so will short-sellers. All that selling will drive prices lower.

We're not there yet.

Last week, I neglected to stress that the stocks I was talking about were among the weakest around. With small-caps underperforming mid- and large-caps, those particular stocks would likely do poorly.


Here are the next three items to add to your trading checklist.

Item #4: Keep an eye out for spikes in volume...

"Volume equals validity".

The most common mistake traders make is interpreting any spike in price as proof that a trend is taking shape.

That ain't necessarily so.

What you want to see is an advance in price on heavy volume. If a stock that trades an average of 575,000 shares a day moves up 5.25% over three days but at the same time trades only 75,000 shares each day...

That means there's no conviction behind the move. The price is not being pushed higher by institutional buying. We have no reason to believe the advance is part of a larger campaign by hedge funds to accumulate the stock.

On the other hand, if that same stock moves up that 5.25% while trading 2,250,000 shares per day... now we're talking. Clearly, the big funds are building a position in the stock.

Item #5: Check for any significant news on the security over the past few days...

You never want to dive into a stock only to find out a day or more later that the company is being sued... just lost a valuable, big customer... or has announced that the rock star CEO is retiring.

So take a few minutes to look at the headlines, and at the company's most recent press releases.

Pay close attention to any indications that a new acquisition is about to take place.

And don't forget to keep abreast of earnings announcements. I'm skeptical of stories that tout "expectations". I want to see if price action confirms (or contradicts) a move I expect, given the news I'm seeing.

Item #6: Study price action over different time frames.

You always want to trade in the direction of the larger trend. If a stock has moved up over a few days or weeks, don't get bullish unless it's also in a longer-term uptrend.

Likewise, don't look to get bearish, and play a dip, until you confirm that the stock is in a longer-term downtrend.

You should also make a habit of checking the intraday chart. I do this when I want to conform that it's time to pull the trigger on a trade.

Say you're following a stock in a long-term uptrend. It recently pulled back before closing higher for one day.

Then on the following day, the stock opens higher. Now it's the day after and the stock is up a bit.

You can confirm your bullish idea by looking at that day's intraday chart set to show five-minute bars. (Where each candlestick represents five minutes' worth of trading activity.)

You're looking to see if the up candles (over five minutes) show heavier volume than the down candles.

If so, you can feel confident there's conviction behind the price action you're seeing.

In a future conversation, I'll add more tips to round out our trading checklist.

Until then...

Thank you as always for your time and attention,

Bill Spencer

Editor-in-Chief, True Market Insiders