Large Pause in Smallcap Rally?

Small-caps have been outperforming since the March 2020 bottom, indicating risk appetite among investors. This changed about a week ago.

Below is the Nifty Smallcap 100 relative to the Nifty 100, which we're using to track this relationship of small-cap versus large-cap performance. In early August, it pushed to nearly 4-year highs but quickly reversed to confirm its bearish momentum divergence.

Click on chart to zoom in

This is an interesting change of character since all the potential bearish divergences we've seen this year have not been followed by any significant price correction. This is information in itself.

So what does it mean from a practical point of view? In the short term, it means that the trend of small-cap outperformance is at least due for a pause. It would be irresponsible to be long this ratio until it clears this resistance, so we'll have to wait to see if this failed breakout works itself off through time or by correcting further in price.

We are also watching the S&P BSE Smallcap Index with 688 constituent stocks. It faced resistance at 161.8% Fibonacci extension and reversed to confirm bearish momentum divergence. The reward/risk scenarios remain unfavorable as long as the price is below 26,900.

If the situation in small caps continues to deteriorate, we need to follow strict risk management and position sizing practices. We need to have a plan and know where we're no longer interested in holding our positions.

Thanks for reading and please let us know if you have any questions!

Allstarcharts Team