If there was a single phrase to describe the market in 2011, it would have to be “investor uncertainty”. Investors have been anxious for the last year, and for good reason: incompetent politicians have had significant control over the broad market. Now that we’re in the new year, I think that the single most critical factor for stock performance remains Europe.

First, though, let’s take a look at what’s been going on across the pond. To fully grasp the problems that have been plaguing the PIIGS countries, it makes sense to take a look at what was going on in debt-plagued countries like Greece and Spain for the last several years. In a recent article, Bloomberg reporters took a look at the “Cayenne Crisis” spreading through Spain as the used car market gets flooded with $88,000 Porsche SUVs that middle-class Spaniards realize they can no longer afford:

Juan Ramon Valdivia, 19, who works at his family’s restaurant in Malga on Spain’s sourthern coast, is looking to unload his Cayenne for a less expensive VW or Peugeot.

“This car was the paradigm of how we lived above what we could afford,” Victor Conde, marketing professor at Madrid’s Universidad Nebrija, said.

Teenage restaurant workers being approved to buy Porsches is only part of the problem. The fact that 98% of wealthier Greek swimming pool owners lie on their tax forms is another. And the massive debt loads that a handful of the Eurozone’s least stable economies undertook is the nail in the coffin.

Europe’s debt crisis has remained one of the biggest black clouds for U.S. markets, driving some of the past year’s most memorable crashes. In 2012, it’s still going to be one of the biggest factors impacting uncertainty and volatility in the stock market.

As Europe’s financial instability teeters, investors are betting against the euro. In fact, as I write, short selling in the EU’s currency is at a record high — spurred by investors who are concerned that the PIIGS could take down the whole region’s currency. Worse, they fear that a default on Europe’s sovereign debt could destroy the banks that own huge positions in eurozone bonds.

We’re seeing that play out in the TED spread, a measure of the perceived health of commercial banks. The TED spread is the difference between the interest rates on interbank loans (known as eurodollars) and on U.S. treasuries — when the difference is large, it indicates that investors are factoring in bigger risk to the financial system.

Right now, the TED spread is the highest it’s been since the height of the financial crisis. That tells us that investors are more anxious about the financial system than they’ve been in years. And that’s carrying over to the behavior we’re seeing in the stock market…

Even though stocks have been trading relatively flat for the last week and change, investors should be getting ready for things to get worse before they get better — the financial system can’t be as risky as it is right now without some consequences.

And since the TED spread measures interbank credit risk, those consequences are going to show themselves in the financial sector. You see, even though the TED spread tells us that risk is ratcheting higher under the covers, we haven’t seen that risk get priced into financial stocks by nearly the same amount. As a result, a bet against financials makes a whole lot of sense right now…

One of the easiest ways to do that is through the Direxion Daily Financial Bear 3X ETF (NYSEARCA:FAZ), an exchange traded fund that tracks three-times the inverse of the financial sector’s performance. So, in other words, for every 1% that financial stocks fall, FAZ rallied by 3%. While leveraged ETFs hold additional risks, it still makes a lot of sense for traders who approach this as a short-term, aggressive bet.

We’ll be keeping a close eye on the macro technical environment in the next few weeks — and keeping you filled in here at the Penny Sleuth.

Sincerely,

Jonas Elmerraji
for The Penny Sleuth

Highs in the TED Spread

Why You Should Be Betting Against Financial Stocks was originally featured in the Penny Sleuth.

Thumbing through the financial pages of any newspaper, I could pick out a half-dozen conflicting, convoluted, or crazy market predictions for the second half of 2011. And none of it is doing much good for individual investors.

When the volume of noise on Wall Street gets too high, it makes sense to tune it out and take a look at the only data points that matter. I’m talking about the technical charts.

Today, I want to show you why the S&P 500 Index could be in store for a rally this month, and what it means for your own portfolio…

First though, a bit of background. As far as I’m concerned, the S&P 500 is the most important index for stock investors to watch. It’s made up of the 500 biggest stocks on the market – so it’s a pretty good proxy for the stock market as a whole. Here’s a look at what the S&P 500 has been doing for the last year:

Even if you’re not an experienced technical analyst, you can tell a couple of things about this chart right off the bat. For starters, the market has moved significantly higher in the last year. And the market has hit a sort of “ceiling” ever since the middle of February.

That ceiling sits at around 1,350…

With the exception of a few trading days in early May, the S&P 500 hasn’t been able to sustain a climb above 1,350 in 2011. As a result, 1,350 is a price level that technical analysts refer to as a resistance level. It’s a price where supply of stocks exceeds demand.

But resistance levels do eventually break – and when they do, rallies can ensue.

Since the S&P 500 is such a significant barometer for the broad market, investors can benefit in a big way by holding stocks when that sort of breakout occurs. The trick is spotting when.

Here’s a zoomed-in look at what’s going on in the S&P right now:

The index is showing us a technical formation known as an inverse head and shoulders pattern. It’s a setup that demonstrates exhaustion among sellers. Most importantly, it gives buyers the signal when it’s time to buy.

You’ll want to keep a close eye on the resistance level in the S&P 500 right now. If the index pushes above 1,350 (and holds there), then we could see a meaningful rally in the S&P.

Remember that this isn’t the first time the index has tested 1,350. Any sort of breakout in the index will need to be significant – not just a flirtation with 1,351. That said, traders shouldn’t underestimate the significance of a push above 1,350 – or the impact it could have on stock prices to end the year.

Cheers,

Jonas Elmerraji
Penny Sleuth

Chart Smarts: Why July Could Bring a Rally in the S&P 500 was originally featured in the Penny Sleuth.

Yesterday the market’s latest IPO, Pandora Media (NYSE:P) rallied double digits. Back in May, LinkedIn’s IPO (NYSE:LNKD) rallied 47% in its first day of trading.

Again, to most people, double-digit gains in a day seem pretty impressive.

But I recommend you stay out of the IPO market… until it flashes the “buy signal” that I’ll show you in this alert. I’ll show you the buy signal in a moment.

But first, here’s why I recommend you stay out…

Despite the red hot start, if you bought shares of LinkedIn the day it started trading, you could be down more than 38% on the year – shares have been moving lower steadily since.

Likewise, if you bought Pandora at the height of Wednesday’s trading, you could be sitting on losses of 30%. Here’s another chart:

So much for buying a “hot IPO,” eh?

You see, the current slew of IPOs (and yes, there are many more in the pipeline) is predicated on hype and promise, not cold hard numbers. While that may fly in a more buoyant market, it’s a toxic situation given the weakness stocks have seen since the beginning of June. It’s something that I wrote about following LinkedIn’s IPO – hopefully you weren’t suckered into the new, hyped names that have started trading since.

All of that said, there is a way to profit in spite of weakness in the IPO market…

In fact, as I see it, the key is finding technically relevant levels on newly-public names. Let me show you a real-world example:

Trading IPO Names For Fun and Profit

Back in late 2010, Tesla Motors (NASDAQ:TSLA) was a lot like LNKD. Shares had gone public in late June of last year, only to peak on their first trading week and move lower over the next few months. But on October 20, 2011, my Penny Stock Fortunes colleague Greg Guenthner and I recommended buying shares – since then the position has rallied more than 40%.

So, what was the key to cashing in IPO gains on Tesla?

The first factor was quality. Even though Tesla’s fundamentals were nascent, the stock was offering a muted valuation relative to its potential. Still, investor exuberance can overpower a stock’s “story” any day of the week – to get the timing right, the stock still had to be a technically relevant buy. Take a look at its chart:

Source: Bloomberg

Even though shares of Tesla had only been public for a few months, the company’s chart told us a wealth about how the market was pricing this stock. After peaking, shares sold off to the $15 level, setting ultimate support. After that, shares carved out two more significant support levels (the thick white and red horizontal lines in the chart above) that offered us a good buying target and stop loss target respectively.

Simply put, support can be thought of as a “price floor” for shares of a stock. They’re levels where shares have found an intermediate bottom – that low point indicates that there’s a glut of demand for shares at that price.

In practical terms, a support level is the price where investors start to think, “Hey… that stock looks cheap!”

Support levels are often the lowest price a stock trades at (at least for a while) not surprisingly, then, investors want to buy shares close to support.

In short, a bounce off of support lines is the “buy signal” you should wait for when looking at these IPOs.

Even though buying Tesla was a long-term position, the factor that made this trade successful was the fact that we picked up shares when probabilities highly favored the demand side of the equation. That’s exactly the scenario that you should be shooting for on any IPO trade regardless of your time horizon.

From a technical analysis standpoint, LinkedIn is starting to look like Tesla did – but it’s still too soon to tell whether it will make a good buy. Shares still have yet to set a meaningful support level.

My recommendation: give the latest batch of IPOs a few months… wait for the “buy signal” to flash… and then look for a chance to buy just above support.

Sincerely,

Jonas Elmerraji
Penny Sleuth

Chart Smarts: Squeezing Gains From This Toxic IPO Market was originally featured in the Penny Sleuth.

Today, I want to show you how we netted 45.5% gains in a recent trade with a low risk buying strategy… And how you can do the same thing on your next trade.

Any active investor would likely admit that the last couple of months have provided an incredibly difficult trading environment. Stocks have mostly traded sideways since the end of February, only to be met with a brutal selloff in the last week that’s left the S&P 500 a mere 1.74% higher than where it opened this year. More speculative indexes, like the NASDAQ Composite, are up even less.

They key to success in this sort of challenging market is to constantly keep your eyes open for trading opportunities. That means maintaining a watch list of potential plays, and monitoring the preset price level when they should become active trades. That’s exactly how we found this quick trade.

The trade was one I recommended to my Penny Momentum Trader readers for shares of Zale Corporation (NYSE:ZLC). So, to be clear, we’re not talking about hypothetical examples here – we’re looking at a real world trade that many of my subscribers book real cash on…

If you’ve followed my Chart Smarts articles here at the Sleuth in the past, the setup that spurred this trade is hardly exotic; it’s a double bottom:

A double bottom is a setup that identifies strong support for shares. Think of it as a sort of “price floor” that share prices have trouble moving below. The reason for the existence of a price floor is the fact that a large pocket of demand for shares exists at that price – it’s a level where people start thinking “…that looks cheap, I’ll buy some.”

On a double bottom, the buy trigger comes when shares move above the intermediate peak between the two bottoms. But in the case of Zale Corp., an upcoming earnings call after the breakout occurred substantially increased the risk of the trade.

For a pre-earnings trade, there are generally two ways to approach it. The first is to take a small starter position in advance of the earnings call – and expose a smaller chunk of shares to the risk of an earnings miss. And the second is to wait for earnings to get released, then take the trade…

We opted for the second, waiting to see how earnings panned out the next morning before taking on the risk of a new position. Because earnings came in above Wall Street expectations, we entered early in that day’s market session, taking advantage of the buying strength that resulted from new investors taking notice of Zale’s strong numbers.

I recommended that readers either buy shares outright, or pick up a particular call option on the trade for a higher-risk alternative. Most importantly, we set our maximum risk and reward before actually taking on the trade. Maximum risk came in at the stock’s previous resistance level of $4.28 (the breakout level for shares), and maximum profit came at just shy of $5.88 – the stock’s previous 52-week high.

These numbers were the “high probability” outcomes for the trade…

In the end, shares rallied hard, reaching our target price just two days after we entered the trade. Readers who opted to take the low risk stock approach had the chance to book 17.8% gains – while those who bought the call option I recommended had the opportunity to make 45.5% (or more, in some cases) in that two day window.

There are a few key takeaways from this trade that traders should be taking note of:

Build a Watch List: First is the importance of constantly keeping an eye out for emerging trades – the double bottom setup in Zale looked attractive, and we were ready to make a move when it triggered.

Watch Our for News Factors: Another important factor was adjusting our trade entry to avoid added risks of Zale’s earnings numbers. While we left some gains on the table by doing so, we significantly reduced our risk exposure, and still walked away with large profits.

Set Your Targets First: Finally, we set our stop loss and price target ahead of time, ensuring that emotional trading wouldn’t keep us from speculating on what was a high-probability technical setup.

While the trading environment continues to be challenging in June, following those three factors ensures that we’re ready to take advantage of the next high-probability setup when it comes along.

Cheers,

Jonas Elmerraji
Penny Sleuth

Chart Smarts: Generating 45.5% Gains With a Low Risk, 2-Day Trade was originally featured in the Penny Sleuth.

“The cloud,” or cloud computing, is offering to change the way we interact with technology spanning from computers to cell phones and everything in between. In essence, cloud computing relies on a data network to fuel the device you’re using with content — in many cases, content uniquely tailored to you. That could mean, for example, that your personal photo album is stored remotely so that you can view it on multiple devices. Or it could be something as common today as a Gmail account that you can access from both work and home.

In both cases, the idea is data being on the network — not necessarily on the device. As high-speed data connections proliferate to nearly any conceivable location, innovative companies are creating new ways to take maximum advantage of the cloud. But we’re not writing to tell you about one of those this month. Instead, we’re writing to you to recommend the IT infrastructure stock that everyone else hates…

Why would we do that? Simple: Because like so many important technologies, the cloud is facing a serious scarcity problem, and in a manner of speaking, our company owns the “keys” to the cloud.

You see, while companies are creating amazing new cloud experiences, they’re reaching capacity problems when they reach a certain scale. That’s because firms have limited storage capacity on hand today — and that storage (and, more importantly, access speeds to reach the data) is only becoming more in demand as new data-intensive services come online.

That short supply of storage space has led some companies to take drastic measures.

Among the hardest hit have been U.S. cellular carriers. Overwhelmed by increased data demands from a new wave of smartphone customers, firms like AT&T and XO Communications are plowing billions into their data center infrastructures just to keep up. Another firm that’s dumping billions into cloud data capacity is Apple: The California-based iPhone maker is in the process of completing a $1 billion private data center facility in North Carolina ostensibly to handle the demands of the mammoth download volume used by its iTunes Store.

At the same time, scores of other firms are plowing truckloads of money into upgrading existing facilities or building new IT infrastructure of their own. There’s considerable capital spending going on in this industry right now.

This month, at Penny Stock Fortunes, we’ve found a firm with a solution to the data center problem. It’s also a firm that hasn’t been getting much love from Wall Street lately — shares have been beaten down more than 37% year to date. But that’s exactly why we think now’s the time to buy. And we tell readers exactly why in our latest issue…

Right now, you can subscribe to a full year of that Penny Stock Fortunes’ research for less than the cost of a monthly cup of coffee at Starbucks. For that, you’re entitled to our full array of small-cap research and recommendations – recommendations that have yielded open gains like 240% on Kapstone Paper and Packaging Corp. (NYSE: KS), 50% on Advance America (NYSE: AEA), and 40% on Solta Medical (NASDAQ: SLTM).

With our “cloud computing” play still well within our buy range, now’s the ideal time to start a risk-free subscription. Click here to learn more…

Sincerely,
Jonas Elmerraji
Managing Editor, Penny Sleuth

May 19, 2011

Why Now’s the Time to Buy the Tech Company Everyone Else Hates was originally featured in the Penny Sleuth.

In retrospect that was clearly a “profitable” idea. But more than a few investors who acted on silver are scratching their heads, wondering just how long they should hold. It’s great to take gains in silver, but those gains aren’t real until you know when to get out.

This brings me to a recent reader question:

“I was wondering if you feel Silver will continue to run a bit more like Gold? (I know they run together, but wondered if silver has gone too far?)”
- C.B., Houston TX

For starters, markets can go much higher or lower than we think or we feel. When “think” is the key emotional measurement, it often leads to trouble and lack of trading discipline. Truthfully, the less you think, the easier it is to evaluate trading opportunities.

Every financial investment has the same time tested process and methodology. Here’s the list I’ve shared with my Resource Trader Alert readers in the past:

1.    Identify
2.    Execute
3.    Manage
4.    Maximize

The number one focus always has to be on risk: What is the downside, and what are the implications on the portfolio if wrong?

Only after determining that the potential rewards outpace the potential risks does it make sense to move forward with a trade.

My preferred strategy is to trade limited-risk options with enough time to be right. The option vehicle has unlimited upside with limited loss – that’s why they’re ideal for traders who can’t sit and watch the markets all day long.

Silver Psychology

As of this writing, the recent high price in silver futures currently sits at $49.82. That’s the level prices reached briefly on April 25. It’s also a historically significant price – you see, the long-standing target from silver’s 1980 rally (aka the Hunt brothers’ fiasco) sits at a round, psychological $50 an ounce. Gold had long ago achieved those 30-year-old levels and it only made sense that silver would as well.

Previously, we haven’t seen a major unwinding that made the reward to risk appealing enough for a bullish silver play. The danger has been too high for our entry criteria and the market has gone without us. Sometimes it is better to miss a play.

With the price chart accelerated to almost unsustainable levels a breakdown is in the works. We’re already seeing it in the market’s last few trading sessions.

[Editor’s Note: This pullback in price could be the ideal entry point for silver. If you’re not comfortable taking on silver options trades, there are more accessible alternatives to get silver exposure in your portfolio today. The easiest comes in the form of the iShares Silver Trust (NYSE: SLV), an exchange traded fund that holds physical silver on behalf of its investors.]

It all comes back to commodities,
Alan Knuckman
Penny Sleuth

May 3, 2011

A Trader’s Take: Should You Still Buy Silver? was originally featured in the Penny Sleuth.

Dear Penny Sleuther,

Although market volume is a crucial piece of investment information, the majority of the public is ignorant of it. Fundamental analysts do not consider volume, whereas technical analysts underutilize it. In my new book Investing with Volume Analysis I discuss how volume provides essential information in two critical ways: by indicating a price change before it happens and by helping the technician interpret the meaning of a price change as it happens.

Here’s a look at how you can harness the power of “the force” to predict and interpret price action in small-cap stocks…

Volume Leads Price

Although practitioners of technical analysis and academia have often been at odds, volume information is one area where they tend to largely agree. Volume can provide essential information by indicating a price change before it happens.

The message is extremely telling, particularly when the volume reaches extreme levels. During such times, volume offers far superior information than price alone could ever provide. Authors Gervails, Kaniel, and Minglegrin of “The High Volume Return Premium,” a white paper from The Rodney L. White Center for Financial Research of The Wharton School, University of Pennsylvania state, “We find that individual stocks whose trading activity is unusually large (small) over periods of a day or week, as measured by trading volume during those periods, tend to experience large (small) subsequent returns.” The researchers further state, “A stock that experiences unusually large trading activity over a particular day or a week is expected to subsequently appreciate.”

The testing results of their 33-year study comparing stocks that experience relatively high volume surges compared to normal and low-volume stocks is illustrated in the chart below. Similar conclusions were confirmed by Kaniel, Li, and Starks of the University of Texas. Their research paper, “The High Volume Return Premium and the Investor Recognition Hypothesis: International Evidence and Determinants,” concludes:

“We study the existence and magnitude of the high-volume return premium across equity markets in 41 different countries and find that the premium is a strikingly pervasive global phenomenon. We find evidence that the premium is a significant presence in almost all developed markets and in a number of emerging markets as well.”

Source: “The High Volume Return Premium,”
The Wharton School University, Pennsylvania

Volume Interprets Price

The second critical way in which volume provides information is by helping traders interpret price.

Volume enables the analyst to interpret the meaning of price through the lens of the corresponding volume. The authors Blume, Easley, and O’Hara (1994) reported in “Market Statistics and Technical Analysis: The Role of Volume,” in the Journal of Finance, “volume provides information on information quality that cannot be produced by the price static. These researchers demonstrate how volume, information precision, and price movements relate, as well as how sequences of volume and prices can be informative. Moreover, they also show that traders who use information contained in market statistics do better than those trades who do not. Thus, technical analysis arises as a natural component of the agents learning process.”

However, price alone represents the vast majority of the work within technical analysis. As such, this book gives volume the significance it is due as an essential element of investment analysis.

Yet doing so without also discussing price is also insufficient. Volume cannot be properly understood without price any more than price can be adequately assessed without volume. Independently, both price and volume convey only vague market information. However, when examined together, they provide indications of supply and demand that neither could provide independently.

Ying (1966), in his groundbreaking work on price-volume correlations, stated, “Price and volume of sales in the stock market are joint products of a single market mechanism; any model that attempts to isolate prices from volumes or vice versa will inevitably yield incomplete if not erroneous results.”

From my research I have found that volume is a very valuable variable in stock analysis and its effects are more significant upon smaller capitalized overlooked securities. As such, I believe this translates well for the penny stock investor looking to employ volume analysis concepts into their own research efforts.

Sincerely,
Buff Pelz Dormeier, CMT
Penny Sleuth

April 15, 2011

Editor’s Endnote: To learn more about integrating volume into your trading, Buff’s new book, Investing with Volume Analysis, provides an accessible in-depth view of this essential technical metric. To grab your own copy, and profit from the hidden forces behind market moves, just click here…

Excerpted with permission from Investing with Volume Analysis: Identify, Follow, and Profit from Trends by Buff Pelz Dormeier (FT Press; 0137085508).

Use “The Force”: Harnessing Volume to Predict and Understand Stock Prices was originally featured in the Penny Sleuth.

Historically, when stocks fail to produce gains, investors have turned to “safer” alternatives like gold or silver, bonds, and money market funds. But safety is a relative term – while these alternative asset classes do typically outperform bear markets for stocks, it’s a big mistake to think of metals like gold or silver as a safe alternative to the broad market.

That’s because the volatility on metals is often as high (or higher than) volatility in stocks. Silver, as measured by the iShares Silver ETF (NYSE:SLV) has rallied more than 115% in the last year – that’s far from “safe”.

Of course, high volatility in metals isn’t a bad thing. In fact, it’s a good thing for traders looking for tactical buying opportunities.

So, how do you use that volatility to your advantage? One incredibly effective strategy is to look for high-probability technical trading opportunities in metals, then turn to junior mining stocks as a means of magnifying a move in the metal. Because bullish breakout potential is forming in heavily traded metals like gold and silver right now, it makes sense to pay close attention to what’s going on in this market.

Want to see what I mean? Take a look at the charts of gold and silver futures below:

These charts show both metals nearing strong resistance levels (the horizontal grey lines). A breakout above those levels suggests that precious metal bulls have absorbed excess supply of futures contracts, and that the spot price of gold and silver are free to move higher.

And because small-cap mining stocks have share prices that are tied very closely to the price of the metals they mine, a breakout in either metal presents an excellent buying opportunity for junior mining stocks…

Here’s a rundown of three of the precious metals stocks that present attractive technicals right now:

• Kimber Resources (AMEX:KBX): This gold stock is seeing a strong resistance level at $1.80. Traders should wait for a break above that level before going long.

• Mag Silver Corp (AMEX:MVG): An ascending triangle setup in Mag Silver presents a potential buy on a move above $13. Until then, this isn’t a high-probability trade.

• International Tower Hill Mines (AMEX:THM): Here’s another gold stock that’s seeing strong resistance right now. In this case, our upside barrier is right around $10.50. If THM can sustain a move above that price, shares should be able to move significantly higher.

Keep in mind that I wouldn’t recommend buying any of these three stocks at this time – instead, they’re stocks that could make good buys if they can manage a move above their respective resistance levels.

Happy Trading,

Jonas Elmerraji
Penny Sleuth

Why Penny Stock Investors Should be Watching for a Breakout in Metals was originally featured in the Penny Sleuth.

Today, we’re going to fill that void by looking at head-and-shoulders trading tactics through the lens of a real-world trade that gave my Penny Momentum Trader readers a chance to book 51% gains in just five days. Here’s everything you need to know to do the same…

It’s important not to get too caught up with patterns. Ultimately, patterns are just an easy way to describe significant technical price action in stocks – they’re not an end unto themselves. That’s evident in the fact that an estimated 90% of traders lose money. But by applying trading rules to patterns, that number can shrink significantly.

Simply put, a head-and-shoulders pattern is a bearish formation that’s made up of three “peaks” in a stock’s price action – one large peak (the head), and two smaller peaks on either side (the shoulders). It signals a top in a stock. Remember, though, it’s not the pattern that’s important, it’s what the pattern represents: a head-and-shoulders is a good indication of exhaustion in a stock’s share price – as trading volume declines in the head, and prices fail to reach previous highs in the right shoulder, the market’s giving serious indications that bullish powers are waning.

Statistically, the head-and-shoulders pattern is worth watching. An academic study conducted by the Federal Reserve Board of New York suggests that the results of 10,000 computer simulated head-and-shoulders trades resulted in “profits [that] would have been both statistically and economically significant.”

Like I said before, though, the toughest part of successfully trading a head-and-shoulders pattern isn’t in identifying it in a stock chart; instead, it’s the challenge of picking the right entry and exit points.

For a real world example, let’s take a look at Endeavour Silver Corp. (AMEX: EXK), a small-cap silver company that I recommended to my Penny Momentum Trader readers back on March 2. Shares of EXK had been forming an attractive inverted head-and-shoulders pattern, an upside down head-and-shoulders that’s a bullish setup.

Take a look at the chart below for a visual description of this stock’s price action:

The “buy” trigger for EXK came on the first day that broke the stock’s “neckline” (also sometimes called shoulder level), the line that connects the small peaks on either side of the shoulders. It’s not enough that shares broke above the neckline, however – what traders should be looking for is a confirmed breakout. That means conclusive evidence that the push higher is more than just a minor intraday whipsaw.

Good confirmation includes a close above the neckline, followed by an open above it the next day. More conservative traders would be wise to wait for two consecutive opens above the neckline, just keep in mind that your extra margin of safety comes at a cost of lost potential gains.

The key to a successful exit on the trade comes from setting a realistic target price. In a head-and-shoulders pattern, the general rule for determining a target price comes from measuring the distance from the peak (or trough) of the head to the neckline. Then, measure that same distance on the other side of the neckline – that’s your price target.

For us, we opted to close out the trade on the first trading day that breached our target price (the dotted red line in the chart above). By doing that, we actually managed to capture near-maximum gains – as you can see from the chart, prices reversed just days after we sold.

Ultimately, readers who bought the option I recommended were able to cash out 51% gains in just 5 trading days.

By setting your trigger buy price (at the neckline) and your target price ahead of time, you’ll be able to take emotion out of your trades, define your potential gains ahead of time, and statistically improve the percentage of winning trades in your portfolio.

Obviously, there can be a steep learning curve to technical trading – but with practice, it can become as comfortable to you as any other investment method. When just getting started, I’d always recommend using paper trading before you sink real cash behind any new strategy.

Cheers,
Jonas Elmerraji
Penny Sleuth

March 18, 2011

Chart Smarts: How to Trade a Head-and-Shoulders for 51% Gains was originally featured in the Penny Sleuth.

Before you begin thinking about where to go from here, it’s important to take a critical look at the market at large. Things aren’t pretty right now, but that doesn’t mean you should sit on your hands. Now is the time for a critical look at your portfolio. In short, it’s time to get defensive. That’s why I’m detailing three steps you need to take to save your portfolio from a correcting stock market.

1.    If you have a weak hand, now is the time to fold. Get your weak, speculative stocks off the table. You shouldn’t get bogged down in the stories of these stocks. If these speculative names are falling with the market and breaking support, sell to preserve your capital. Remember, selling now doesn’t mean that you can’t revisit the stock at a later date. Cash is a viable position, and sitting on the sidelines to see where your speculative picks end up when the dust settles wouldn’t be a bad move.

2.    Check the market for recent misses. Look over your watch lists from the past few months. In these pages, you probably have the names of several potential trades that “got away” from you. Now, thanks to the correction, you might have the chance to buy one or more of these stocks at a more reasonable price.

This bit of advice comes with a caveat: don’t rush a new trade while the market is correcting—and don’t buy stocks that are in the middle of a free-fall. Calling a bottom can be difficult—and dangerous. Instead, look for names that have corrected, are on or above support, and are showing signs of life.

3.    The trend is still your friend. Here’s a helpful take on momentum versus trend. It comes from Jeff deGraaf, a highly respected technical analyst and alumnus of Lehman and Merrill Lynch. Recently, deGraaf detailed an important distinction between trend and momentum that I want to highlight for you.

When the market has momentum, deGraaf says, you need to participate. In other words, strong market movement should dictate your buying. On the other hand, deGraaf observes that trend is more flexible, allowing you the luxury to wait for good entry points.

Right now, it’s obvious that momentum is not dictating a strong market move to the upside. But it’s also important to remember that the primary trend is not yet broken. Your best bet is to disregard momentum trades in favor of trending stocks to add to your list of trade candidates.

Lately, the market has been opening a door one day, only to slam it shut the next. That’s why you need to be extra careful. You don’t want commissions eating your accounts because you get stopped out of trades every day. If you follow my three tips, you should be in a much better position to profit when the market finds support.

Sincerely,
Greg Guenthner
Penny Sleuth

March 16, 2011

3 Important Steps That Could Save Your Portfolio was originally featured in the Penny Sleuth.