Small-cap stocks rally, but trader needs more proof to trust bounce

Small-cap stocks are living large.

The IWM Russell 2000 ETF, which mirrors the small-cap index, has rallied more than 2% over the past week, roughly double the gains of the large-cap S&P 500.

“There’s no question it’s a positive development whenever you break a sideways range that’s been going on for that long,” Matt Maley, equity strategist at Miller Tabak, told CNBC’s “Trading Nation” on Tuesday.

The IWM ETF bumped up against $160 earlier this month after failing to break through in July and September. It got through this week to head toward $162.

However, Maley needs further proof before he’s ready to believe in this breakout.

“The one thing that makes me a little bit hesitant here … it’s only a small higher high so far. We saw a very similar higher high back in May, a very minor one, and it was a complete head fake. It was followed by a 10% correction over the next month,” Maley said.

After moving above $161 in May, the IWM declined nearly 10% to touch a low in early June. It made a lower low in late August.

“We’re still more than 6% below the all-time high [of 2018]. So, what I’m saying again, positive development, but we do need some more upside follow-through. Whether it happens now or after a little bit of a breather, either way, I want to see more of that before I really turn the green light on for this group,” Maley added.

Quint Tatro, president of Joule Financial, sees opportunity in the small caps as the group begins to show signs of life.

“In an incredible year, this is a group that has underperformed … due in part to its makeup — you’ve got a tremendous amount of regional banks in the group and you also have small oil companies,” Tatro said during the same segment. “We’ve been building the position and we added on the breakout. Why? Because of the risk reward.”

Tatro has a way to play the group in case of further upside from here.

“It’s a simple trade where you put the stop below the breakout. If you’re stopped out, it is what it is but if you’re in the trade and it continues with the momentum you get to new highs,” he said.

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