Today, I’m going to show you how you can use two separate timeframes to fine-tune your market analysis. Checking out the context of the shorter-term move could save you heartache when the pattern follows the big picture story in the charts. It might even help you discover a hidden trade that would not have been visible on a daily chart…

Let’s begin our analysis with a chart of the Russell 2000. It looks pretty nasty:

The chart above is a daily candlestick chart of the Russell. And some pretty interesting things are going on here…

For those who aren’t familiar, the Russell 2000 is an index made up of a group of two thousand small- and mid-cap stocks — when the Russell makes moves, it’s often a hat tip that the broad market is about to do the same thing. And if you’ve been watching a chart of the Russell lately, you’d know it’s crashing.

Frankly, all of the indexes have been falling lately. In fact, with the Dow Jones Industrial Average down 12 out of its last 13 sessions at Friday’s close, the blue chip index was seeing its biggest losing streak since 1974 until today’s bullish open. But none of the indexes were as clearly bearish as the Russell.

In the above chart, the pattern to watch is a head and shoulders top. It’s formed by two intermediate peaks at around the same level (called shoulders) separated by a higher peak called a head. The pattern indicates exhaustion among buyers. Because of its unique look, it’s a popular setup for newer traders.

The break below the neckline at 780 last week was a sell signal for the index…

And now, with our momentum gauge (RSI) pushing into oversold territory, things aren’t looking great for stock investors.

The market looks vulnerable right now. But becoming super bearish could be a mistake —even for a swing trader. In order to develop a better picture of the market’s

A glimpse at a second timeframe for the Russell reveals something interesting going on in the longer-term:

This second chart is still the Russell 2000, but it’s a much longer-term timeframe. Here, every candle marks a whole week’s worth of trading instead of just a day.

In the long-term, things are looking a whole lot less scary. In fact, they’re looking downright positive — that’s because the R2K index is forming a bullish inverse head and shoulders pattern (the opposite of the pattern in the first chart) at the same time. In the context of this bigger setup, the bearish head and shoulders top in the first chart is just forming the right shoulder of the bigger-picture setup.

And when it comes to technical trading patterns, the big-picture setup always wins out…

Looking at the daily chart of the Russell, it’s tempting to go out and make a bet against the index — but the R2K is starting to catch a bid at support just a few points from the price objective that the topping pattern spit out. That means that we could be in store for a stop to the selling this week. Looking at the longer-term picture provided clarity that the more common short-term trading picture couldn’t.

For investors who were quick to act, there was money to be made in the short-term drop, but now it’s likely run its course. Now, a more interesting setup is what happens in the weekly chart if shares can breakout above resistance at 850 — the same price objective rule applied to the upside in the R2K puts a price target at 1050. That’s a 23.5% upside possibility when it happens…

Cheers,

Jonas Elmerraji
for The Penny Sleuth

Use These 2 Charts to Play the Market Drop was originally featured in the Penny Sleuth.

If you were paying attention to the big momentum plays this quarter, you could have pinpointed when the market was ready to turn lower.

Now, with short-term losses mounting, you might have the chance to spot the first buying opportunity by monitoring these very same stocks. When the momentum names begin to catch a bid, we could see the beginnings of an oversold bounce that would send stocks higher in the short-term…

During the first half of 2012, investors fully dedicated their efforts to Wall Street’s momentum darlings. These are the “hot stocks” in the midst of multimonth bull runs. Expectations run high with these momentum names. Valuations run even higher.

It is a ridiculous notion to wait for a correction (or even a pullback) before buying these red-hot stocks. After all, the share price will never fade. Or so the frenzied logic goes…

It’s probably no surprise to you that Apple was the de facto drum major of the momentum marching band. Apple shares shot up more than $230 between Jan. 1 and mid-April — when the furious momentum rally finally topped out.

Apple’s pullback — and the eventual pullbacks in several other overhyped stocks — was inevitable. Apple was displaying all of the classic signs of a blowoff top. The investing public was convinced shares could go nowhere but up. Analysts and the financial media joined the party with their own irrational expectations, including $1,000-plus price projections and declarations that any fund manager who didn’t own Apple should be immediately fired…

But just when the stock appeared to be completely unstoppable, shares abruptly reversed.

The selling wasn’t outright panic. As of this writing, it remains orderly. The market didn’t take an ax to the Apple tree. It only shook it a bit.

It’s how turning points are born. Shorts shake the branches to see if any weak hands fall from the tree. They’re after the low-hanging fruit. These are the folks who bought shares near the height of the rally. Their conviction is far weaker than that of the long-term investors sitting on substantial gains. So they sell. The selling puts enough downward pressure on the price to convince other longs to part with their shares.

Of course, disbelief prompts many buy-and-hold investors to hold shares of a falling stock much longer than they probably should. There are (and will continue to be) many investors who will stand by Apple — even if its decline accelerates. After all, Apple is a great company that makes interesting, in-demand products. But even if expectations from Apple faithful remain high, we doubt the stocks’ incredible performance during the first half of 2012 will be matched anytime soon…

It wasn’t just technology or high-priced stocks that caught the attention of momentum investors.

Smith & Wesson Holding Corp. (NASDAQ:SWHC) — which I recommended to my premium readers in December 2011 — was swept up in the rally that began on Jan. 3.

I didn’t somehow predict the buying frenzy would begin as soon as we recommended the stock. We knew Smith & Wesson shares had held up well during the height of the European crisis last fall. And we had multiple fundamental reasons for picking up shares when we did.

From a fundamental perspective, Smith & Wesson was improving its operations. Management had already started the process of unloading the company’s underperforming security division. Revenue and guidance strengthened as management concentrated on building the company’s core gun manufacturing business.

Gun sales were growing across the board. In fact, gun sales actually booked a one-day record the day after Thanksgiving 2011. The FBI reported a record number of background checks, adding up to nearly 130,000 gun buyers on the day. The old record was set in 2008 — at only about 98,000.

Stories highlighting record-breaking sales throughout the gun industry began to gain traction in the media shortly after our initial recommendation. Attitudes regarding firearms ownership were improving. More and more women were taking to gun ranges across the country. These tangible stories took hold with investors — and the trend that initially pushed shares of Smith & Wesson above $4 in December began to accelerate. A momentum play was born.

By early April, Smith & Wesson shares more than doubled, to $8. With the successes of high-priced momentum plays fresh in their minds, traders and investors jumped at the opportunity to own shares of this fast-moving stock.

But Smith & Wesson was not immune to the momentum sell-off. Shares gave back more than $1 in a matter of hours in early May as new concerns over the economy and eurozone surfaced. Shares have recovered somewhat. And we’re still hanging onto open gains of approximately 95%. But the warning bell has sounded. It’s time to be extra vigilant as skittish investors rush to raise cash during uncertain market conditions.

While the secret of Smith & Wesson’s potential is now more widely known, the stock has a much better chance at weathering the momentum sell-off than some of the more closely followed names on the market. Traders shook Smith & Wesson’s tree. But investors have stepped back up to the plate and bought back shares.

Only time will tell if the stock will consolidate and move higher from here. If Smith & Wesson and other momentum names catch a bid, we could get our first signal of a move higher.

Sincerely,

Greg Guenthner
for The Penny Sleuth

How to Time the Market with Momentum was originally featured in the Penny Sleuth.

If you don’t, you will probably lose money this summer. It’s as simple as that…

After a furious four-month rally, traders are selling stocks again. It’s a buy-and-hold investor’s worst nightmare. No sooner do stocks begin to move higher than the surge is cut short by volatile trading and fear.

No wonder so many people are walking away from stocks…

“Even though American stocks have doubled in price in the last three years, investors and traders large and small keep giving the market the cold shoulder,” declares The New York Times.

The fact is the average investor wants little to do with a stock market that has burned him one too many times over the last decade.

The numbers don’t lie. Trading on all U.S. exchanges has yet to recover since the 2008 financial crisis. Just last month, the average daily trades in American stocks remain about half of what they were before the financial crisis — 6.5 billion shares, compared with 12.1 billion. That stands in sharp contrast to the market shocks of 1987 and 2001. During these two events, normal trading levels resurfaced within two years of the initial crisis, according to The New York Times. Any way you look at it, the recovery in trading activity this time around has been painfully slow.

The Old Gray Lady isn’t the only mainstream news outlet latching onto this story. Even USA Today is chiming in. In early May, the paper forked over front-page real estate to a story about everyday investors shunning the stock market.

Are these front-page declarations that the market is a dead zone true contrarian signals? If so, is the market set to embark on a new epic bull run, due to the magazine cover indicator?

It’s possible. But from my vantage point, it’s simply too early to declare that the market is ready to charge sharply higher. It can be maddening to try to play these huge shifts in sentiment — especially when economic news and data both at home and abroad continue to unnerve investors. So instead of fixating on the stock market as a whole, I want to cut through the noise by focusing on the individual names that have the best opportunity to outperform their peers.

It’s no secret that we’re dealing with a tough buy-and-hold environment — that much we’ve already said. It’s why a carefully planned approach to small-cap investing is so important. More specifically, you should be concentrating on evolving your strategies to insure you will stay ahead of the market.

Ask yourself — What’s working right now? Which strategies will continue to work if the market moves lower — or when economic and market conditions begin to improve?

Obviously, staying ahead of the market should be the primary goal of every long-term investor. And I’m confident that with a little planning and foresight, we can continue to deliver market-beating results, despite uncertain economic conditions.

Here’s how a longer-term investor should be approaching the market right now:

Value: Many smaller stocks are expensive. You should turn to shares you can acquire at a substantial discount. During the first half of 2012, investors fully dedicated their efforts to Wall Street’s momentum darlings. These are the “hot stocks” in the midst of multimonth bull runs. Expectations run high with these momentum names. Valuations run even higher. But over the past month, these stocks have performed poorly. Avoid them. While the market’s trend is in flux, look for an extra margin of safety. These are the stocks with the fundamental backing to weather a storm of selling. Chasing the popular stocks with inflated multiples simply isn’t working in this environment

Timing: If the markets continue to fluctuate, timing your entries into new positions could be the difference between a losing trade and a great investment. You must use all the tools at your disposal to pinpoint ideal entry prices. If a stock’s chart isn’t backing up the fundamental story, move on to other options. There’s just too much risk in trying to guess when a crashing stock will stabilize. Unless you can target a low-risk entry point, walk away. Don’t try to catch falling knives.

Portfolio Management: When the market gives you opportunities to book profits, you take them. On the flip side, when the market warns you that one of your stocks might underperform, you should sell. What’s left is a lean portfolio containing the stocks that offer the best chance to lead you to profits. There’s nothing wrong with taking profits on a name you really like — even with the intention to buy it back when the dust settles.

Sincerely,

Greg Guenthner
for The Penny Sleuth

3 Ways to Survive a Volatile Market was originally featured in the Penny Sleuth.

Liquidity is one of the most overhyped of modern financial ideas. In the context of the stock market, all liquidity means is that you can buy and sell easily. Lots of liquidity means lots of trading volume. It means the bid-ask spread is narrower in a liquid stock than it is in one that is illiquid.

As it turns out, the best opportunities are often the most illiquid. In what follows, we’ll take a look at illiquidity as an investment strategy.

Markets are more liquid than ever these days, but that is not all a good thing…

Back in 1960, investors held their stocks for an average of seven years. No one complained about a lack of liquidity. Today, people hold stocks for on average for four-eight months.

The ability to get in and out of a stock quickly means you have lots of sloppy owners. As Lowenstein points out: “Those who expect to sell out quickly and cheaply are more likely to buy for speculative or foolish reasons and to act as uninformed owners in between times.”

An illiquid stock is, by its nature, more likely to attract a smarter shareholder base. This is simply because the people going in know they can’t get out of it as easily, so they are more careful about how and why they get in.

This may have something to do with the outperformance of illiquid shares.

Roger G. Ibbotson and Wendy Hu of Zebra Capital Management studied the performance of liquid stocks against illiquid ones. They found that illiquid stocks tended to trade at a discount to more-liquid stocks. “Investing in less-liquid stocks thus pays,” they write.

Moreover, they found that less-liquid assets tend to become more liquid over time, thus helping to erase that gap.

Ibbotson and Hu also note that investing in less-liquid securities as a strategy has an advantage in that it “avoids, or invests less in, popular, heavily traded glamour stocks and favors out-of-favor stocks, both of which tend to revert to more-normal trading volume over time.”

That’s all fine and makes sense. But you can really see it in practice by looking at portfolios investors construct.

Nick Padgett and Stephen Mack are the managing directors of Frontaura Capital. The fund invests in frontier markets such as Cambodia or Mongolia. I’ve never met them personally, but hope to someday. I was introduced via email by my friend Doug Clayton at Leopard Capital. They share their shareholder letters with me, and the latest one had an interesting observation on this liquidity idea.

Frontier markets can be very illiquid. It can take weeks, maybe months, to buy even small positions in Mongolian stocks on the Mongolian exchange, for example. This means frontier markets are cheaper, but not always. Frontier markets have some liquid stocks. And the valuation disparity between the liquid and illiquid is great. The most-liquid stocks can trade at the same price-earnings multiples as S&P 500 stocks like Wal-Mart or Intel.

“Thus,” Padgett and Mack write, “those willing to invest beyond the most-liquid frontier stocks could have a performance advantage, provided they remain patient and committed during difficult market periods, when less-liquid stocks may perform worse.”

As evidence of the disparity, consider the MSCI Frontier Markets Index. It is made up of the largest and most-liquid frontier companies. Padgett and Mack don’t own a single stock in this index. “Many of these stocks are good companies,” they write, “but they do not trade at the most-attractive valuations.”

At the time of their letter, Frontaura’s portfolio had an average price-earnings ratio of 6 with a price-to-book ratio of 1 and a yield of 5%. By contrast, the MSCI Frontiers Markets Index had a PE of nearly 11, a price/book of 1.5 and a yield of 4%. Frontaura’s valuations are cheaper in the less-liquid names.

I offer another exhibit of an absurdly cheap illiquid stock: Siem Industries.

This trades on the Pink Sheets under the ticker SEMUF. Siem is a holding company in the oil and gas, marine transportation and shipping industries. Siem owns pieces of Subsea 7 S.A., Siem Offshore and Star Reefers. Siem Industries is another stub play, as these three companies are all publicly traded.

The stake in these three companies is more than double the market cap of Siem Industries.

Siem Industries owns other stuff, too. It owns 100% of Siem Car Carriers, which owns ships that carry cars. It has a stake in a private equity fund that owns a variety of Scandinavian companies. It has stakes in a potash mine and an insurance affiliate. None of this is counted above.

The catch?

The shares don’t trade much. Over the last three months, the average trading volume was 945 shares. That’s a daily volume of about $60,000. And that overstates it. I checked over the last 16 trading days and found that on 11 of those days, no shares traded at all. Not a single share. On many days, you’ll see 200, 400 or 600 shares trade. As I write, the bid-ask spread is enormous. You pay $74 per share to buy and get $63 to sell.

That, I think, is the big reason for the discount. But this is not a situation that will persist forever. In the meantime, there is a whopping discount to the patient shareholder, and probably a rewarding ending.

Note: Siem Industries is not an official recommendation. I think it’s too illiquid for me to recommend here. Too few would get in on the trade.

In any case, liquidity as an investment strategy is a useful idea, as these examples show.

Sincerely,

Chris Mayer
for The Penny Sleuth

Liquidity, Crack and the Quest for Better Returns was originally featured in the Penny Sleuth.

It doesn’t matter if you’re a long-term value investor or a short-term trader. When you’re dealing in stocks, timing isn’t everything — it’s the only thing.

As I was sorting through the mailbag this weekend, I found that many of your questions were about when to buy into a stock or a big investment idea. Today, I want to look at some of the potential trades and investments on your collective radar. I’ll analyze the charts and tell you if you’re looking at a solid buying opportunity — or a potentially disastrous trade…

Let’s get started:

What do you think of Cisco Systems (NASDAQ:CSCO) and Silvercorp Metals (NYSE:SVM)? Is now a good time to buy shares of both?

— S.R.

Here’s what Cisco looks like right now:

Yikes. Cisco is more or less a household name. But this chart is just awful. No one wants to own this stock — and with good reason. The company issued terrible earnings just last week — as evidenced by the massive gap down from $18.50 to $17.25. This gap will now act as resistance. So even though we’re seeing a decent rebound today to the high $16’s, I wouldn’t count on this stock recovering past the mid $17s anytime soon.

Any way you look at it, this thing is toxic. I would avoid it at any price.

Next is Silvercorp:

Here we see a very similar chart — minus the big gap lower. Still, a strong downtrend remains intact. Before you pull the trigger on an investment, draw a line connecting two or more peaks in the price. That’s where you’ll find resistance. Until your stock can break out of its downtrend, chances are it will continue to move lower…

Both of these examples could be considered falling knives. Neither CSCO nor SVM has indicated that it has put in a solid bottom. The important takeaway here is that an out of favor stock needs to time to consolidate after a move lower. Unless you see legitimate signs of life, the stock will probably see additional downside/sideways action before it begins to recover.

As far as questions go, I have one that may fall into your “it’s a bad stock, run away” category. Cameco (NYSE:CCJ), the world’s largest uranium miner. It got hammered after the accident in Japan, and I bought in about a week later. So, you can see what has happened since then. Personally, I still feel that nuclear power is an important cog in the energy machine, and I expect it to return. My question is: is that a rational view, and, if so, is it smart (for the long term) to even consider adding to the position?

— M.N.

Yes, you are expressing a very rational view. Unfortunately, there is nothing rational about the stock market.

Here’s a long-term look at Cameco:

I think you’re analysis is sound. Nuclear is and will remain an important source of energy. But this sentiment is not shared by the market right now. That’s your problem. While you are able to project a stronger future for nuclear energy, the market has yet to move past the events in Japan and the reactions that followed.

Solid analysis will occasionally produce substandard investment results. This is why timing is so important. In this case, you jumped back into nukes way too early. Think of it this way: the market continues to deal with the residual effects of the 2008 financial crisis to this day. And were’ only about a year removed from the nuclear crisis in Japan…

As far as adding to your position — I generally do not advocate averaging down. However, some longer-term investors are fine with buying more shares at lower prices in the hopes that the stock will eventually rebound. It’s more about your investing personality than anything else. As long as you can sleep at night without worrying about your portfolio, you’re probably doing something right.

Keep sending me your charts, questions and concerns to editor@pennysleuth.com.

Sincerely,

Greg Guenthner
for The Penny Sleuth

Monday Mailbag: When to Buy Stocks was originally featured in the Penny Sleuth.

My portfolio has plenty of the first two categories. We have a handful of above-average utilities and energy stocks. But we have only one health care play. If you look at other income-focused portfolios, you’ll find a number of health care real estate trusts and pharmaceutical makers.

Now, we’re not unaware that changing demographics in this country and rapidly growing health care costs have made this a powerful sector. But the numbers are all wrong.

On the real estate side, there are still a number of issues concerning what the property should cost. So smart investors have to remain picky when it comes to hospital and retirement home REITs.

But when it comes to pharmaceuticals, we’re dealing with a whole other set of problems.

We have been covering the ongoing “patent cliff” in name-brand drugs for years now. Some $49 billion in annual pharmaceutical sales are at risk of losing their exclusivity.

And for a drug maker, that’s your most important asset…exclusive rights to make and sell your drugs.

This isn’t some far-off problem. Last year, industry leader Pfizer lost exclusive rights to Lipitor. That drug brings in — or, more accurately, brought in — more than $4.5 billion in annual revenues. That’s a sizable chunk of change.

Others have faced similar challenges. Eli Lilly lost exclusivity to Zyprexa — $1.9 billion in yearly sales. GlaxoSmithKline lost Advair — $4.7 billion in U.S. sales. The list goes on and on. There are also plenty of big drug patent expirations on the horizon. In fact, the majority of these problems are yet to come for most major companies.

Now that we are further along on this patent cliff, other potential plays are popping up. There is one company we recently released to our Lifetime Income Report subscribers…

Up until now, we’ve been a bit cautious to get into it, however. Its long and successful history didn’t give it a pass on this patent cliff problem. It was very much in trouble.

However, through all of this, the company still managed to generate $11.4 billion free cash flow and increase its earnings per share for the 28th year. It has been able to do that in face of some of the stiffest economic environments in history and its expiring patent issues.

And, it has ensured continued growth through their proactive portfolio transformations.

What really strikes us about this company’s approach is how, despite its long legacy, it refuses to be a dinosaur. Its current goal is to realize half of its health care revenue from products developed in the last five years. Considering the backward-looking industry it finds itself in, that’s great foresight…

Sincerely,

Jim Nelson
for The Penny Sleuth

A Crack at One of the Fastest-Growing Sectors in the Market was originally featured in the Penny Sleuth.

But that all changed in 2007, when a ruling from the Options Clearing Corporation opened the market for everyone.

Like most analysts, initially I was skeptical of the profit power of this undiscovered venue. After thoroughly exploring and analyzing these instruments, however, I’m convinced.

This new market is a total game-changer!

If you’ve been burned in the stock market, these instruments could bring you some much-needed income. They offer more than a way out of today’s extreme volatility — they actually let you cash in on the ups and downs that would otherwise rob you blind.

On the other hand, if you enjoy speculating, these instruments are a perfect thrill. They’re inexpensive, pay off quickly (in four days or less) and have strictly limited risk.

If you want a market hedge, this market has you covered, too. With a simple, low-cost trade, you can set yourself up for a payday if news pushes the rest of your investments the wrong way.

In short, these new instruments can help you no matter what your investment style or situation. And I truly believe that everyone should try trading them at least once in their life.

They’re called binary options… and I’ve made it my mission to spread the word about them…

Binary options are simple bets on whether something will happen or not. That’s it.

In a way, they resemble sports bets — like betting which football team will win on Sunday or if a baseball player will hit more than 30 home runs in a season.

Binaries, however, are bets on financial and economic events. They cover things like which way a commodity price will go, how far an index will move, even what a currency’s exchange rate will be.

You pay money to take the bet — called the premium. If your hunch is wrong, you lose your stake. But if your analysis is correct, you get your premium back plus a profit.

Binary options are big in Europe, and big U.S. brokerage institutions have used similar instruments for decades. But they were complicated affairs — created through a mass of jargon and legalese that would make anyone’s head spin.

But an idea this simple — and potentially market-changing — couldn’t be contained. So some brokerages pushed to offer these simple instruments to retail U.S. investors (guys like you and me).

In 2007, they got their wish. The Options Clearing Corporation and the Securities Exchange Commission allowed exchanges to offer regulated binary contracts.

Still, even with the approval, the U.S. binary market remains quite small. The American Stock Exchange and Chicago Board Options Exchange only offer a handful of binary options on a few stocks and indexes. Most brokerages don’t touch them, either.

That’s a real shame, because the global market offers a nearly infinite range of opportunities to put binary options to use.

Fortunately for American investors, one U.S. company understands that potential…

It’s called the North American Derivatives Exchange, or Nadex (www.nadex.com).

Thanks to its pioneering efforts, you now have a chance to make money with binary options — a field that once belonged exclusively to Wall Street’s bigger players.

Nadex offers a full suite of binary options, covering a nearly endless list of strategies and investments.

Until more brokers realize what they’re missing, the easiest thing for you to do is to open an account with Nadex directly.

That might sound like a big deal, but it really isn’t. The site is very user-friendly, and Nadex’s trading platform is one of the most flexible I’ve ever encountered.

(In case you’re wondering, neither my publisher nor I are affiliated with Nadex. We don’t receive any compensation if you open an account or not. It just happens to be one of the few binary exchanges in the United States.)

Another important caveat is that only U.S. citizens can open Nadex accounts.

If you aren’t a U.S. citizen, you will need to look into opening an account with IG Group, Nadex’s parent company, at www.igmarkets.com. It has offices all over the world that may be able to help you.

American citizens have nothing to worry about. In fact, you can instantly sign up for a free demo trading account with Nadex. They’ll give you $25,000 in virtual money to trade as you wish. It’s a 100% risk-free way to learn how binary options work and how quickly you could rack up wins…

Sincerely,

Abe Cofnas
for The Penny Sleuth

How Market Headlines Can Quickly Pay You Triple-Digit Gains was originally featured in the Penny Sleuth.

It takes guts to admit you are wrong. As a trader or investor, you will take losses. If you understand that you won’t book profits on every single trade, you will be better prepared when the time comes to part with a loser.

Remember, the deck is stacked against you. The market is not a level playing field. You are an individual investor going up against Wall Street professionals armed with massive amounts of cash, superior tools and access to endless research. You have to plan ahead— and you have to think like a skeptic in order to survive.

That’s why I helped you develop a basic trading plan last week. Since I published the column, I’ve received countless e-mails asking about losing stocks. You recognize that you’re in a bad spot. Or something about one of your investments just isn’t right. But you’re not sure what to do next.

Today, I’m going to use your questions to reveal three critical investing traps. If you learn to avoid these situations at all costs (or sell out and move on to your next idea) I all but guarantee you will quickly become a more successful trader.

Let’s go to the first question:

What do you think about Radio Shack?

— C.P.

Radio Shack (NYSE:RSH) continues to push to new lows. And I’m not just talking about lows on the year. Shares of Radio Shack are actually trading lower than they have in 30 years…

Any way you look at it, this chart is ugly. From a technical perspective, I wouldn’t touch Radio Shack stock with a 50-foot pole. If you ever pull up a chart that looks like this, just run away.

Here’s the trap: an untrained eye might consider Radio Shack to be a “cheap” stock worth a second look. It’s a recognizable brand that’s down big, so it has to recover at some point, right?

Wrong. You can’t assume a stock presents some sort of value opportunity just because its shares have taken a beating. In the case of Radio Shack, the company appears to be in trouble. It’s sales are dropping. The business is under a ton of pressure from online retailers such as Amazon. And the only products the stores seem to be selling are lower margin items.

In short, this “cheap” stock is a trap. Avoid at any price.

I work for a living and I can’t be glued to a computer during the day. So can I purchase a penny stock and put a stop order in and if so what percent would you suggest?

— M.C.

When you are dealing with smaller stocks, stop losses can be tricky. I’ve always recommended “mental stops” instead of a hard and fast stop order. Here’s why…

If stocks have a volatile day, you might get stopped out of a position that immediately recovers from its initial drop. Usually, smaller stocks are not as heavily traded. So shares tend to suffer from large temporary price swings.

That’s where the trap lies.

If a smaller stock drops on lower volume anywhere near your stop loss, chances are it will be taken out, only for the stock to recover and move higher.

As long as you’re not daytrading or dabbling in very small names, you should be able to rely on closing prices for your stop losses. If you have a predetermined mental stop based on where the stock closes, you can easily check the market in the evening. If you have to sell, you can have an order ready to go for the next morning.

There is one tiny company that I’ve been watching for months and while it has won awards and even huge contracts, this stock still sits below 10 cents a share and just seems to sit. Sometimes I’ve seen it jump 20-30% then fall right back down.

— M.R.

The problem here is lack of volume. A stock isn’t going to move if there’s no one interested in buying or selling shares.

Lack of trading volume can trap you in a stock with no way to get out at a reasonable price. I don’t care how well the company is performing — or how nice its chart looks. If no one is trading it, there’s little to no chance of it breaking out.

When you’re looking at smaller stocks, one of the first things you should note is the average volume. I like to see at least 100,000 to 200,000 shares traded every day. And that’s on the low end. Anything less than that can get you into trouble. If you do get trapped in a low volume stock, try to sell at the best price and move on to your next idea.

Sincerely,

Greg Guenthner
for The Penny Sleuth

How to Avoid 3 Critical Investing Traps was originally featured in the Penny Sleuth.

OLED display screens — short for organic light-emitting diodes — offer far greater energy efficiency, along with brilliant colors and durability.

I’ve seen video clips of mobile OLED screens being smashed with hammers and not looking the worse for wear. A standard LCD screen would shatter into dozens of shards. In addition, OLED allows for transparent and flexible screens, which opens up a new world of possibilities for display technology. CNNMoney’s site lists transparent screens as the big technology breakthrough of 2012, although they got the name of the technology wrong.

The visual aspects of a breakthrough display technology, however, are only part of the story…

Mobile devices bring additional challenges, requiring the application of additional technologies.

Mobile computing devices are, obviously, small. This complicates their use, since there isn’t much room to cram a display and keyboard interface onto them. As a solution to the problem, mobile devices have been dropping mechanical keyboards and moving to touch screens.

Screens are no longer just output devices. They are now input devices as well. Sharing input and output functions in the same physical space means display screens can be larger. That’s easier on the eyes. Touch screens are also easier and more intuitive for many mobile applications compared with toggles and trackballs.

Several types of touch-sensitive displays exist, but the most-popular variety today is known as the capacitive touch screen. A capacitive touch screen includes an insulating layer, like glass, that sits on top of a conducting layer. Current manufacturing techniques use indium tin oxide (ITO) for the conducting layer.

Touch screens allowing multiple simultaneous touches feature a coordinate grid layer of electrodes, which each act as a sensor. Since the human body conducts electricity, when the insulating glass layer is touched, a potential electrical difference is created between the finger (or thumb, as the case may be) and the ITO elements.

This electrical phenomenon acts as a signal that is sent to a microcontroller, which interprets it so it can be used to sense input by a device’s operating system. Microcontroller functions include receiving the raw data, cleaning up background noise, interpreting the size and shape of the touch and calculating the exact coordinates of the touch. Touch has revolutionized the mobile computing market.

So just how big is the touch market? According to Walker Mobile, a mobile display market analysis and information firm, the touch screen market grew from $1.5 billion in annual revenues in 2008 to over $6 billion last year.

DisplaySearch, another market analysis firm, forecasts this market to grow to over $22 billion by 2016.

The market is expanding rapidly, and this year, we also have some near-term catalysts to accelerate the touch screen business.

Microsoft’s Windows 8, for example, will feature increased support for touch screens. Microsoft’s new user interface, called Metro, is specifically designed to use them. I had a chance to demo the Windows reboot at the Consumer Electronics Show earlier in the year. It is a big improvement over Microsoft’s initial attempts to include stylus touch functionality in tablet computers.

With the launch of Windows 8, there will be a wave of new touch-enabled mobile devices at the end of the year. However, we’ll also see touch interfaces accelerate their move into traditional computers.

Intel, always a close Microsoft partner, revealed an Ultrabook reference design that includes the tech. Ultrabooks are a highly portable, high-performance segment of the notebook market that is being promoted by Intel. They are expected to post strong growth within the PC segment over the next few years and will be a huge driver for touch screen technology.

With continuing strong growth in touch-enabled smartphones and tablets, as well as new touch-enabled PCs, there is a huge opportunity for companies in the touch screen business.

The semiconductor industry has been going through a soft patch, but it isn’t expected to be touch-and-go for much longer. With Windows 8, touch-enabled Ultrabooks and flexible touch screens all starting to go live by the end of the year as well, it is a great time to start a position in the touch screen market.

Ad lucrum per scientia (toward wealth through science),

Ray Blanco
for The Penny Sleuth

Nothing Touches This Market… was originally featured in the Penny Sleuth.

The idea of selling in May and going away is an old Wall Street adage that’s based on the seasonality of summer stock prices. Historically, May through September tends to be the weakest period of stock performance — and that fact is fresh in recent memory. In 2010, the S&P fell 8.2% in May. In 2011, Mr. Market fell more than 17% during the summer months.

But don’t get too startled by the numbers. Two years does not a market rule make…

Think about it: if everyone decided to blindly sell in May and go away until the Fall, then June would become a pretty good time to buy — stocks would become so undervalued that opportunistic buyers could pick up bargains by the fistful. And a quick Google search shows just how popular this “market rule” is; a quick search of the phrase returns 54.7 million hits.

In reality, “sell in May and go away” is just another one of those clichés that doesn’t mean a whole lot without context. It’s like telling someone to “buy low and sell high” or “diversify”; unless you know specific steps to do those things correctly, it’s worthless.

In the context of a bearish market, sell in May and go away can be a bit of added information that the drop is going to be especially painful. But in the context we’re in now (a correction after a bull run), it’s meaningless…

To show you that context, I want to share three charts that add some important color to what’s going on in the S&P 500.

The first is a look at the S&P’s advance-decline line, a measure of market strength:

Taking a look at the indicator, it’s clear that the uptrend in the A-D line is still in force. In a nutshell, that indicates that a larger number of stocks are still participating in this rally. So even though the S&P has corrected for a few weeks, the underpinnings of the market remain strong.

Next up is volatility, as measured by the Bollinger Bandwidth of the S&P 500:

In case you’re not familiar, Bollinger Bands are statistical measures of how volatile stocks are right now. When the bandwidth reading gets higher, it tells us that stocks are “risky” right now; when it shrinks, the market is relatively smoother. With the bandwidth reading trending towards 52-week lows right now, we’ve got a good indication that volatility readings are due for a spike.

In other words, if that S&P 1,430 target is correct, it could come quickly…

But that leads to another important question: just how high can stocks safely go right now? Taking a look at historical levels, the answer may surprise you. This chart from Bloomberg tells an interesting story:

The chart measures the value of the S&P 500 as a percentage of the gross domestic product of the United States. In other words, it’s a look at how valuable [predominantly] U.S. companies are versus the value of all of the trade that takes place within U.S. borders.

Historically, stock values have eclipsed GDP — barring the massive price swings of 2008, the market hasn’t been holding at these “cheap” levels for the better part of a decade. Typically, I’m not a huge fan of platitudes like “stocks are cheap”, but in this case, it does do a good job of showing us what’s going on in the broad market.

From there, we’re clear to apply solid technical analysis to figure out which stocks investors think are cheap right now, and pounce when high probability trades pass through our crosshairs.

The bottom line is this: don’t sell in May and go away. Instead, look for the trades with big targets on their backs. Technical traders should be looking for breakouts and bounces off of support. Fundamental investors should be scooping up the bargain names. Buying in May and deciding to stay could fuel your gains for the rest of the summer…

Cheers,

Jonas Elmerraji
for The Penny Sleuth

Selling in May and Going Away was originally featured in the Penny Sleuth.