Small-Cap Bear ETFs Awaken From Hibernation as Reopening Rally Stalls

Fed's caution about duration of U.S. recovery rattles small caps

Small-cap stocks have outperformed their larger peers by about 10% since the March bottom amid the group's heavy dependence on the U.S. economy and expectations of a faster-than-expected recovery from the pandemic. Therefore, it's no surprise that small-cap issues led a broad market sell-off Thursday as investors became increasingly anxious that a speedy bounce-back could stall if a virus resurgence curtails reopening efforts and causes consumers to rein in their spending.

Furthermore, the economy's health returned to the spotlight after Federal Reserve Chair Jerome Powell cautioned about a long road to recovery at the central bank's June monetary policy meeting. "The Fed keeping rates steady through 2022 could give investors the impression that the Fed may be more concerned about the pace of economic recovery than originally anticipated," said Joseph Sroka, NovaPoint's chief investment officer, per Reuters.

Traders can position for further falls in small-cap stocks with the following three inverse exchange-traded funds (ETFs) that move in the opposite direction to the Russell 2000 Index. Below, we discuss the details of each fund and explore several trading possibilities.

ProShares Short Russell2000 (RWM)

Created in 2007, the ProShares Short Russell2000 (RWM) seeks to return the inverse daily performance of the Russell 2000 Index. The fund, which yields 1.36%, particularly suits tactical traders who want a short-term bet against smaller financial and health care companies, given those sectors make up roughly 35% of the underlying benchmark. Miniscule bid-ask spreads, along with a daily turnover of more than 3.3 million shares, ensure that small-cap bears can quickly enter and exit positions while minimizing transaction costs. RWM holds $491 million in net assets, charges a 0.95% management fee, and has tumbled almost 20% over the past three months as of June 12, 2020.

The ETF's price has trended lower within a narrow falling wedge pattern over the past month, falling below key support at $36. Thursday's breakout on heavy volume above the pattern and this previous trading floor indicate a possible head-fake trade that could give way to further short-term gains. Those who buy the fund should place a stop-loss order below $36 and target a move to overhead resistance at $44.

Chart depicting the share price of ProShares Short Russell2000 (RWM)

ProShares UltraShort Russell2000 (TWM)

The ProShares UltraShort Russell2000 (TWM) aims to generate twice the inverse daily return of the Russell 2000 Index – the same benchmark used by RWM. A razor-thin 0.03% spread and deep trading liquidity make the fund a popular choice for those seeking slightly more aggressive short exposure to the small-cap space. The fund's 0.95% management fee sits in line for a geared product that uses derivatives to achieve leveraged returns. As of June 12, 2020, TWM has assets under management (AUM) of $137.02 million, offers a 1.47% dividend yield, and is trading 42.76% lower over the past three months.

Small-cap bears' ability to push the price above the top trendline of a falling wedge pattern yesterday coincides with a bullish moving average convergence divergence (MACD) crossover above its signal line. Swing traders who anticipate more upside should consider placing a stop order underneath Thursday's low at $11.09 and booking profits close to horizontal line resistance at $16.50. Manage risk by amending the stop to the breakeven point if the ETF closes above the 50-day simple moving average (SMA).

Chart depicting the share price of the ProShares UltraShort Russell2000 (TWM)

Direxion Daily Small Cap Bear 3X Shares (TZA)

Traders who want to position even more aggressively against small caps should add the Direxion Daily Small Cap Bear 3X Shares (TZA) to their watchlist. The highest-leveraged fund in the segment has an objective to return three times the inverse daily performance of the Russell 2000 Index. Traders should note that returns greater than one day may deviate from the fund's advertised exposure due to the effect of compounding. More than 17 million shares exchange hands per day on average penny spreads, making the ETF ideal for exploiting intraday fluctuations. As of June 12, 2020, TZA controls AUM of $702.4 million and has fallen 64% over the past three months.

Yesterday's breakout above a falling wedge pattern occurred on the ETF's highest trading volume since its 2008 inception, giving conviction to the bullish move. Active traders who enter at current levels should set a take-profit order near $41.50, where price encounters resistance from a horizontal trendline and the 200-day SMA. Protect against a failed breakout by cutting losses if the fund closes beneath the May low at $22.71.

Chart depicting the share price of the Direxion Daily Small Cap Bear 3X Shares (TZA)
Take the Next Step to Invest
The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace.