A tale of Two Indices

Let’s evaluate two of the major US stock indices for potential trading opportunities. But why two US indices? Surely they must all be highly correlated and it doesn’t matter which one to trade, right?

“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness …” The U.K. referendum is behind us and in its wake a lot of market uncertainty and volatility. This ‘turbulence’ will probably remain for quite some time as market participants try to figure out what the impact of the Brexit outcome might be on the global economy. This week the news is flooded with speculation that the UK government may not even heed the outcome of the vote, (meaning Bremain may still be on the cards) whilst others maintain that the vote to Brexit will stand, and that the government will invoke article 50 of the Lisbon Treaty. 

 

What will happen next? Which scenario will ultimately come to pass? I don’t know but one thing as a trader, I am constantly seeking opportunities in the markets. Whether Brexit or Bremain comes to pass, there will definitely be opportunities as the markets either rise or fall.

Let’s evaluate two of the major US stock indices for potential trading opportunities. But why two US indices? Surely they must all be highly correlated and it doesn’t matter which one to trade, right? While it is true that different stock indices usually have a high correlation, there are noticeable differences. The two indices I want to analyse today are the S&P 500 which consists of the 500 biggest US companies and the Russell 2000 which consists of small cap companies.

Let’s focus on the big picture here by looking at the weekly chart above for the S&P 500 chart (US SPX 500-Cash):

Price has been trying to push past a flat level around 2,130 with three big touches of that level around April 2015, October 2015 and April 2016. During the last run up (February until June) price established a new uptrend and price made a new higher high by breaching this major resistance level. Then of course Brexit happened and price cashed making a lower low. Yet, this market doesn’t look that bearish to me, at least for now.

Let’s compare this now to the Russell 2000 (US Small Cap 2000 – Cash):

The small cap index peaked in June 2015 and has established a series of lower highs and lower lows since then. The index is currently trading approx. 14% off of its highs while the S&P 500 has lost about 4%. Chart structure of the Russell 2000 signals more weakness than that of its peer index. So you can see in these charts, that “yes” the markets are highly correlated (meaning they move in the same direction more often than not) but at the same time the extent of these moves differs across both meaning that overall chart structure is quite different.

Is it now the best of times or the worst of times? Like anything else it probably comes down to perception and your idea of what the markets will do next. I know that I will most likely prefer the S&P 500 for any potential bullish setups and the Russell 2000 for any bearish plays that might set up in the next few days and weeks. Let’s hope, that this is truly the age of wisdom for all of us.

Happy Trading!