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A Smart Way to Consider Small Caps

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The last day of April and the first day were unkind to equities, but prior to that, small-cap stocks and the related ETFs were soaring. Recent strength the Russell 2000 Index could bode well for the PowerShares DWA SmallCap Momentum Portfolio (NasdaqGM: DWAS).

DWAS follows the popular Dorsey, Wright & Associates proprietary selection methodology that is designed to identify small-cap firms with positive relative strength characteristics in an attempt to follow companies with strong forward momentum. The ETF follows the Dorsey Wright SmallCap Technical Leaders Index.

DWAS’s index is “designed to identify companies that demonstrate powerful relative strength characteristics based on that company’s market performance. Approximately 200 companies are selected for inclusion in the Index from the Nasdaq US Benchmark Index,” according to Invesco.

Diving Into DWAS

At its core, DWAS is a momentum-based strategy – one that could prove rewarding if the recent small-cap rally proves to have legs.

Momentum investing can target those companies that are exhibiting high levels of growth. The momentum factor selects company stocks that have recently outperformed based on the idea that “the trend is your friend” and that stock market leaders typically continue to outperform. This type of strategy can be an effective way of targeting growth-oriented companies since stocks with positive momentum often continue to generate strong earnings.

“What makes DWAS a compelling idea over the near-term is historical data indicating that small caps accrue momentum comparable to what was built in recent days, it usually translates into notable out-performance in the following month,” reports Nasdaq.

High momentum stocks are those that are capable of rising very fast in a short period of time, which makes them very attractive to potential buyers. However, in many cases, these stocks can also crash unexpectedly and carry significant risks as a result. When handled properly, however, momentum trading can be a rewarding method of profiting from the stock market.

“What’s left out of DWAS is also relevant for investors. While small-cap stocks can continue soaring over the near-term, it’s unlikely to be on the back of energy names with oil prices sliding. Nor is that upside likely to be led by smaller financial companies that are being plagued by historically low interest rates,” according to Nasdaq.

Rather, DWAS allocates about 58% of its combined weight to healthcare and technology stocks.

For more on multi-factor strategies, visit our Multi-Factor Channel.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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