The High Drama Trendline Break

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The IWM, ETF for the small cap-led Russell 2000 index, broke its major support trendline dating back to the October 2011 highs today. The reason why that trendline is important is due to how many times the market reacted strongly to it. However, price has had trouble navigating back up to the resistance trendline lately, and thus we became “heavy,” lingering just above the support trendline recently. What you want to see is a sharp, violent bounce off the trendline in order for it to stay true. If and when price starts to hang out just above it, the likelyhood of a break increases.

Now, the issue then becomes what significance a break of the support trendline actually takes on. To be sure, bears will make a huge deal about this, claiming it as sound evidence that the overall bull run is finished, and we are now headed towards a vicious bear market. In reality, though, an initial break of the trendline often serves as a mere shakeout. When everyone is looking at the same thing, no one is really looking. Thus, just as the trendline becomes too obvious, the market has a knack for the highly dramatic trendline break.

After that, though, we often see price consolidate and turn back higher, as though nothing had happened. Again, this is what usually happens on the first break of the major trendline. I am not out in front of the market positioned for a sharp reversal higher. However, I am cognizant of not being overly dramatic about today’s trendline, as it is usually a trap lure in eager bears, at least initially. After the initial break and potential recovery, though, the landscape becomes increasingly dicey and you cannot count of these breaks being mere shakeouts. Food for thought, going forward.

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