Bullish index potential

The charts of two indexes indicate that they could be poised for a sustained rise

This month’s technical analysis highlights two charts that are both potentially poised for powerful breakouts to the upside, and if the breakouts occur, they could justify a rally of at least a further 10%.

The first chart is the Russell 2000. This is an index in the US that tracks small cap stocks on the New York Stock Exchange. The index has been trading within a sideways range between 1 110 and 1 210 for the better part of the past year. It has bumped up against the upper boundary of that range on a number of occasions during the year but has not managed to breach the 1 210 resistance on a sustained basis.

What is interesting to note is that the lower boundary of the range was pierced in October last year. But that break to the downside did not last long and buyers stepped in aggressively to take the index back inside the range, meaning that the break downwards in October was a false break. When a false break occurs within a sideways trading range as we’ve seen here, it often results in a powerful break to the opposite end of the range. In this case that would imply a high likelihood of a break to the top of the sideways range. A break beyond 1 210 would be a bullish development and would open a measured medium-term target of 1 320 — 10% higher than where the index level now.

Small cap stocks are often latecomers to a bull market. If that theory is to hold true in this instance, then it is quite likely that the Russell 2000 index of small cap stocks will need to play catch-up to the S&P 500 and Dow Jones industrial average which have both put on a good show over the past year while the Russell 2000 has been trading sideways.

Investors who wish to take advantage of a potential breakout on the Russell 2000 index can do so through the iShares Russell 2000 ETF which is listed in New York. This is an exchange traded fund that tracks the performance of the Russell 2000 index.

Another chart poised for a potential break higher is the FTSE 100. This index represents the largest 100 stocks on the London Stock Exchange. Like the Russell 2000, this index has been tracking sideways for the past year in a range between 6 200 and 6 900.

This sideways range represents a correction in time for the FTSE 100 as opposed to a correction in price. This lengthy sideways correction in time is deemed to be healthy as it allows earnings to gradually catch up with the level of the index, meaning that the valuation of the index is now “cheaper” than it was at the time when the consolidation began a year ago. This increases the potential for a rerating in the index level to the upside. From a technical perspective, the 6 900 level represents significant overhead resistance that has been tested several times over the past year.