Much credit goes to large-caps for pulling the broad market out of April’s sell-off abyss. But traders looking for other plays this summer may want to consider downsizing with small- and midcap plays.
“Small-cap equity ETFs have staged a bit of a turnaround in the second quarter,” said TMX VettaFi Investment Strategist Cinthia Murphy. She noted a monthly 3% uptick in the performance of the iShares Russell 2000 ETF (IWM) in Q2.
Indeed, the primary small-cap performance indicator, the Russell 2000, is starting to make its V-shaped formation in its YTD chart. The S&P 500 is already back in positive territory en route to a checkmark formation if upward momentum continues. Small-caps tend to make a latent rally, typically after large-cap momentum starts to dwindle.
That said, now could be an ideal entry point for small-cap trading. Even long-term investors can reap the benefits of the low valuations relative to their larger-cap peers.
“U.S. small-cap stocks are trading at nearly a 55% discount to large-caps, as measured by the price-to-earnings ratios of the Russell 2000 versus Russell 1000,” Murphy added.
The prospect of interest rate cuts could also turbocharge small-cap performance. Many small-cap companies rely on debt to keep the proverbial lights on. If the cost to service that debt comes down via rate cuts, it allows for small-cap companies to free up cash for reinvestment in operations. That helps them grow their businesses, as small-caps aren’t typically looking to stay small for the duration of their business life.
3x Small-Cap Exposure
Traders looking to generate big gains from bullish small-cap bets can look to the Direxion Daily Small Cap Bull 3X Shares (TNA) as a potential opportunity. The fund tracks the Russell 2000 Index. As mentioned, it’s the quintessential benchmark for tracking small-cap performance.
The obvious kicker with TNA is the 3x exposure for traders to maximize their profit potential. Experienced traders should only use leveraged funds. That’s because, as appealing as profiting from 3x exposure sounds, it can also go the opposite direction and amplify losses. Given the volatile nature of small-caps, market experience is imperative when trading TNA.
A Median Option
Traders who don’t want the high-beta volatility associated with small-caps can opt to take a median option with midcap equities. Midcaps offer a Goldilocks solution, balancing the stability of large-caps while also exhibiting growth characteristics of small-caps.
Like TNA, traders are able to 3x their exposure to midcaps with the Direxion Daily Mid Cap Bull 3X Shares (MIDU). The fund provides 300% exposure to the S&P MidCap 400 Index. The index is essentially the midcap iteration of the S&P 500 minus 100 companies.
With the 3x leverage, both funds are trailing the S&P 500 for now. But that could all change quickly with momentum. If large-caps run out of steam, look for both small- and midcaps to rally. That’s even more so if rate cuts take place sooner rather than later.
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