Trading the ES (Large Caps) vs. ER2 (Small Caps)

08/13/2008 12:00 am EST

Focus: STRATEGIES

John Netto

Author, The Global Macro Edge

As a person that actively trades the markets, I am constantly looking for an angle to find a better way to be in markets that exhibit certain harmony. Over the last five years, the relationship between the S&P 500 futures and the Mini Russell 2000 futures has demonstrated a very nice harmony. As the attached weekly charts shows, the end of 2002 saw small cap stocks take off on a meteoric rise compared to their large cap brethren. The dynamics of easy money and a recovering US economy all portended well for the smaller firms more affected by their ability to gain access to liquidity than the large cap firms.

The trend played itself out both technically and fundamentally over this time. In 2007 with the onset of the credit crises, it became evident that smaller, less capitalized firms would suffer more as a lack of resources to pull capital from would adversely affect them. Throw in the 11% energy component of the S&P 500, one is left with a large cap component that rallied nicely against the small caps. The one thing I have pointed out in other media circles when asked about a bottom is the ratio between large cap and small cap stocks. This is something I update on a regular basis on my site as it can help you not only select which markets to trade, but where we are at in the overall cycle.

If you have a question as to the computation of the spread, please email John Netto at jnetto@osoktrading.com.

 

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