Today, we’re taking a look at the market’s technicals – and what you need to watch for to profit in this environment…

Right now, a lot of attention is being put on the movement of the S&P 500 index. That’s not surprising – after all, the S&P is widely known as a good proxy for the broad market. In the past six months, price action for this mammoth index has been fairly one-sided: all told, the market has rallied 17% over that time, bringing many analysts to question just how much longer the market can hold up its highs.

Those highs have the market at pretty critical levels, after all. Just this month, the S&P hit a new 52-week high of 1296.25, the highest point in the S&P 500 since September 2008. And at present, around 72% of market analysts and institutional investors are bullish – an incredibly high number given the market’s mixed economic fundamentals and the already impressive run stocks have taken in the last six months.

So, should you be unloading your assets right now? Not quite…

Tempering Our Technical Predictions

To make accurate, actionable predictions about the market, it’s crucial to adapt to the way the market moves. As traders, our predictions should be a series of “if, then” statements: if this happens, then I think that will happen. If the market pushes above a key resistance level, for instance, then we’ll probably see another bull run in 2011; if the S&P slides through support, then it’s time to bet on the short side of stocks.

So, what’s our “if, then” mentality telling us at the beginning of 2011?

Take a look at this three-year weekly chart of the S&P 500 below:

Sure enough, the S&P hit an upside barrier as expected at 1296.06 last week, a level that’s within 0.30% of our pre-determined resistance price. As a result, I think we can make a fairly good case for stocks to behave as predicted in the short-term. While traders may see continued consolidation to end January, it’s still too early to call a top in the market.

It’s crucial to remember that stocks can move lower and still remain in a bull market. Just look at June 2009 or Spring 2010, periods in the chart where stocks moved lower, but ultimately reached higher ground.

So, while the potential for a momentum bleed off in stocks is very real right now (either through a pullback to support or sideways action), calling a top in stocks is a bit ambitious. Instead, we should expect that the S&P will hold above 1275 as it makes another attempt at breaking above that 1300 resistance level.

It’s only if the S&P 500 falls below 1275 that traders need to worry…

Cheers,
Jonas Elmerraji
Managing Editor, Penny Sleuth

January 25, 2011

Chart Smarts: Why You Should Expect Continued Gains in Stocks was originally featured in the Penny Sleuth.

To be sure, trading in this environment requires special attention – after all, earnings season is notorious for increased volatility as the market absorbs the latest earnings news. Here’s a look at four trading tips that could mean the difference between a botched trade and earnings season successes.

1. Watch Earnings Call Dates, and Trade Your Plan

Whether you’re a long-haul fundamental investor, a short-term technical trader, or some combination of the two, the key to success in the markets is to trade according to your plan. That means embracing your strategy, and looking for “high-probability” trade opportunities.

That all changes when you invest in a stock ahead of earnings…

Earnings season adds a considerable amount of event risk to your portfolio. That’s because strong earnings or a major miss can have a potentially massive impact on a stock’s share price. That’s especially true now, when increased market volatility means that those moves can be illogically large.

Unless you have an investment strategy that specifically uses the risks of earnings surprise to your advantage, it’s a good idea to be cautious about buying (or shorting) stocks ahead of earnings.

2. Don’t Forget About Market Holidays

Even if you’re planning on closing out a position ahead of earnings, unforeseen factors can work against you. Take market holidays, for example – forget that the market will be closed, and you could be forced to hold over earnings.

I’ll admit, that exact loss-inducing goof has happened to me in the past…

Once, I put in an options trade, planning to close out the trade ahead of the company’s earnings call. Unfortunately, while I was well aware of the market’s closure for a market holiday, I hadn’t factored it in when I originally set up my trading plan. Although I’d intended on selling the options ahead of the call (which would have given me a relatively nice gain), I got stuck holding calls during an unpleasant earnings call, and ended up closing out most of the position for a loss.

Sometimes, trading your plan isn’t enough – it’s also essential to readjust to meet the market’s irregularities.

3. Gauge Extended Hours Trading for Sentiment Swings

Because most earnings calls occur outside of trading hours, extended hours trading (which takes place before 9:30 a.m. and after 4:00 p.m.) can be an excellent way to gauge sentiment for fast-moving stocks.

Typically, pre-market and after-hours trading is a very good indicator of how a stock will move during the subsequent trading session. By taking a look at the direction and magnitude of an extended-hours move, you can generally get a glimpse of which way daytraders will be focusing on moving the stock. If you’re contemplating a long-side trade, a strong reaction to earnings typically suggests that you’ll do well to buy when the market opens.

On the other hand, a bad earnings day suggests that it’s best to wait for trading to shake out the downside on the stock before it’s time to buy. When you stay aware of the market’s predilections, you’ll be much better prepared to reap better entries on your trades.

Cheers,
Jonas Elmerraji
Penny Sleuth

January 20, 2011

4 Trading Tips for Earnings Season Success was originally featured in the Penny Sleuth.

Those reasons are precisely why we specialize in analyzing penny stocks…

But we wouldn’t pass up a high growth opportunity just because of a stock’s size. Today, I want to tell you about a real trade I placed last week that let me buy into a massive $64 billion firm at penny stock prices… then sell for a 37% gain just a week later. More importantly, I want to share how you can use this strategy in your own portfolio as early as this afternoon.

If you haven’t guessed by now, I’m talking about trading options. Options can be a scary proposition for new traders – after all, with expiration dates, terms like delta, gamma, and theta, and bizarre commission structures, these instruments can be intimidating. Even so, their pure profit potential makes them worth learning about. For our purposes, I’m going to assume you understand options basics (if not, click here to get the gist).

On January 5, I bought Ford $17 March 2011 Call options at $1.39 per contract. In other words, I bought options that gave me the right to buy shares of Ford (NYSE: F) for $17 up until March 19 of this year (options expire on the third Friday of each month). Because Ford was trading for around $17.50 when I bought my options, my purchase price was made up of intrinsic value of 50 cents (the true value of the options) and extrinsic value of 89 cents. That extrinsic value comes from the potential for the options to increase before expiration.

By owning those options, I was able to substantially increase my potential gains – after all, while a mere ten-cent move in Ford’s stock would have been a 0.5% gain in Ford’s shares, that same ten-cent move would have meant a 7.2% move in my much cheaper, $1.39 options (ignoring changes in extrinsic value).

So while shareholders of Ford were stuck with tiny blue chip gains, options gave me penny stock-sized profit potential on this $65 billion company…

Ultimately, my trade worked out as planned, and I was able to close out my Ford options yesterday for $1.90 per contract – a 37% gain in a single week. Obviously, the same rules apply to other blue chip companies, but there are some things to keep in mind if you’re considering trading large stocks for similar profit potential.

1. Picking the Right Play

One of the most intimidating factors about options is the slew of choices you have – with a handful of different strike prices and a dozen expiration dates for each, it can be overwhelming to figure out which specific play makes sense.

There’s no right or wrong answer when it comes to picking an option play. Each offers a different mix of risk and reward. As a technical swing trader, I pick my strikes and expiration dates based on the technical setup for the stock I’m trading – after all, I already should have a pretty solid idea about price targets and time frame before I enter any trade.

Solid options trading takes time and practice – the best way to get good without risking your cash is by paper trading. You can check out a list of paper trading tools on our website.

2. Watch Commission Structures

Commissions are a bit different than traditional stocks, especially if you’re used to flat rate fees from your broker. Typically, brokers charge a flat fee per contract (a contract controls 100 shares), or a flat fee plus some sort of minimum. In the Ford example, a single contract had a cost of $139; had my commissions been 2.95 per contract, a 10 contract order would have cost me $29.50 in commissions each way (buying and selling).

You should always calculate your total round trip commissions before placing any trade, and make sure that the cost makes sense given your potential gains. Remember, most options brokers offer multiple fee structures for different kinds of traders. If one makes more sense financially, don’t hesitate to change it up.

3. Getting Options Approval

Some (but not all) brokerage firms require special authorization to trade options before you’ll be able to execute your first options trade. Most of the time, that’s because brokers want to make sure that you understand the risks associated with these more volatile instruments before you put your cash on the line. On occasion, the lack of authorization for options trading can cause you to miss out on an appealing setup – that’s why you should make sure that you’re set up to trade options before you start researching setups.

If your broker is forcing you to jump through excessive hoops to trade options, consider a new broker.

While options trading does involve a somewhat steep learning curve, the payoff can be massive if you know what to look for. While the benefits of penny stocks are undeniable, you shouldn’t overlook options plays on blue chips for similar-sized gains.

Cheers,
Jonas Elmerraji
Penny Sleuth

January 13, 2011

Collect Jumbo Gains on Blue Chip Stocks Using Options was originally featured in the Penny Sleuth.

Fact of the matter is that nearly every trader – novice and professional – has had this happen to them. But trades that are instant losers don’t have to be botched. Pullbacks are often salvageable situations that can eventually put gains in your pocket.

Today, I’m going to show you how you can still profit from a pullback…

As with the other articles in the Sleuth’s Chart Smarts series, we’re eschewing cherry picked hypothetical examples and taking a look at a real-world trade from my premium Penny Momentum Trader service.

On December 13, shares of Origin Agritech (NASDAQ: SEED) broke above a key level I’d been watching, triggering a buy of the stock under my STORM System (my PMT readers saw the trade coming – I analyzed the technicals in their video Watch List the week before). So we bought shares and call options, recording an entry price of $10.13.

But as soon as we bought shares, this stock started trading lower…

When a trade starts to move against you, the most important thing to remember is not to let your own psychological responses (stress, anxiety, and anger) cloud your judgment as a trader. Whenever you buy a stock as a technical trade, you should already have your exit plan in mind.

In our case, two paragraphs that I wrote in my buy recommendation were all it took to spell out exactly what course of action we should take:

With SEED, we’ve got a soft upside resistance level at $10.60, and a harder resistance level at $11.50. If we can clear the first resistance level, we should be looking at upside potential nearing 18% in the next month or so for SEED’s stock…

For downside protection, I’m recommending a mental stop-loss level of $9.40, a 4% capital risk at current levels.

In other words, if shares closed below $9.40, we’d close the position to protect our capital. And if the trade worked in our favor, we’d aim for $11.50. By pre-setting a stop-loss at a technical level that made sense (in this case, the breakout level we’d been watching for so long), we avoided the influence of external elements (like our own fears) in the trade.

Sure enough, shares moved right down to $9.40… But they did not move below it.

It’s fairly common for shares to pull back following a big breakout. It’s an opportunity for a stock to bleed off some overbought momentum and test newfound support. Remember, though – a stock moving down to support is not something to worry about in and of itself. In fact, I view a stock’s move down to support as a good thing when it causes a bounce higher; it means that shares are being obedient to our technical cues. Only when shares fall through support do we have something to worry about.

But if we didn’t come into our trade with a specific plan, it would have been all too easy to let panic set in, and sell for a small loss. Instead, we held on per our trading plan:

Shares performed exactly as expected, bouncing higher to our target price, and giving us the opportunity to sell for $11.24, an 11% gain on the stock and a 49% gain on our option in just 21 days.

By closely following our plan, we actually profited from this pullback.

So can you. On your next trade, think out your exit contingencies before you buy any shares – ask yourself when you’ll sell if the trade goes your way, and when you’ll sell if it doesn’t. Your trading plan shouldn’t be set in stone – it should be modified to meet market conditions, but don’t make the rookie mistake of not honoring the stop loss levels you set when you bought. Unless you have a valid, market-driven reason for changing your stops, follow them precisely.

Also, don’t get caught up with doubling down on a stock when it pulls back. Remember, when you buy based on technical analysis, you’re a trader not a value investor. Dollar cost averaging can be a big mistake if shares actually fall through that support level you’re watching.

Want to profit on your next pullback? Follow your plan closely.

Cheers,
Jonas Elmerraji
Penny Sleuth

January 11, 2011

Chart Smarts: How to Profit from the Pullback was originally featured in the Penny Sleuth.

It’s all thanks to a simple, but underappreciated strategy that’s helped scores successful traders become millionaires by seeking out single-digit profits on their trades: I’m talking about frequency.  Today, I want to show you exactly how 1% gains can build wealth – and how you can put this strategy to work for your own portfolio in 2011.

First, let’s get back to that 1% trade…

You see, only knowing that we booked average gains of 1% doesn’t really tell us anything at all. That’s because there are two components to performance numbers: gain size and duration. Each is equally critical to just how much your portfolio grows.

Think about it this way: if you could guarantee a 1% gain each trading day, your average gain at the end of the year would be that paltry 1%. Hardly anything to write home about. But because your holding period is so short (just a day), in a single year, your portfolio would have gained 252% in total (since there were 252 trading days in 2010).

If you’d factored in compounding, that same 1% average gain would have left you with 1,127% profits by the end of the year…

So, if you had a $10,000 portfolio, those compounded 1% average gains would translate into single-year trading earnings of $112,740.02.

Obviously, if you missed your 1% benchmark, you’d take home less, and if you hit an occasional 5% homerun, you’d bank much more. The point, however, is indisputable – small, repeatable gains can turn a modest portfolio into a windfall.

How to Focus on Frequency

But while frequency has clear upside potential, it’s a strategy that’s sometimes difficult to put in place – especially if you’ve been a buy-and-hold investor in the past. The key to improving your trading frequency is to focus heavily on your sell signal before you enter your trade. In other words, you need to have an exit strategy in place before you have your entrance planned.

That’s a difficult pill for many investors to swallow – particularly if they’re used to buying stocks they like and holding on for an undetermined amount of time.

For traders, who should ostensibly have target exit prices and stop loss levels in mind for any trades, that’s a less daunting plan to put in place.

Of course, there are potential hiccups to increasing your trading frequency. One is the impact of commissions on small position sizes. If you’re aiming for consistent 5% gains, you need to be sure that you’d have enough profit left over after trading commissions to justify the risks.

Another potential problem is the pattern day trader rule, which limits traders with account sizes of less than $25,000 to 3 day trades for every 5 business days (a day trade is a trade that’s opened an closed in a single trading day). For that reason, it’s essential to keep track of any day trades you may make if your account falls below the threshold.

Putting Frequency into Practice

By hypotheticals are one thing – real life examples of trading successes are another…

The last few months of 2010 were an excellent example of the power that trading frequency can add to your portfolio. In September, I launched my small-cap trading service, Penny Momentum Trader, as a free BETA to readers of the Penny Sleuth (it’s since graduated to Agora Financial’s roster of premium advisory services). By December 31, 2010, our average booked gain rang in at 19.27% in just 22 days. That’s an average annualized return of 319.7%.

That was all done without resorting to day trades, and without taking on more than a small handful of positions at any one time.

And we beat the S&P 500 index by more than 4.8x from the start of our trading.

If you don’t have any experience with shorter-term trading, I’d recommend starting off by “trading paper” first – that is, opening a demo account with your broker that allows you to place hypothetical trades based on real market data. It’ll give you a glimpse of how your higher frequency plays fare without risking real cash.

Cheers,
Jonas Elmerraji
Penny Sleuth

January 4, 2011

Trading Strategy: How You Could Retire on 1% Gains was originally featured in the Penny Sleuth.

But when used intelligently, options can significantly increase a trader’s profitability by magnifying stock gains while limiting risk to your initial investment (unlike traditional leverage, which can actually leave you owing money).

Many people don’t realize that options can actually be traded on tiny companies, but when used with penny stocks, options can provide some truly supersized gains.

Here’s a real-world look at how using options on a recent trade could have put 100% gains in your pocket this month…

The trade I’m talking about isn’t some hypothetical example, though. It’s a real trade that I recommended to Penny Momentum Trader readers back in the last week of November. Now that my premium readers have booked their gains, I wanted to share exactly how we caught this swing trade in advance, and how you can do the same.

Back in November, shares of Alaska Communications Systems Group (NASDAQ: ALSK) popped up on our radar. The small-cap company, which provides communications services in the country’s largest state, had been locked in an uptrending channel for the last several months. An uptrending channel is a technical analysis pattern that binds a stock’s price movement in an upward range – in ALSK it looked like this:

As you can see, the black lines at the top and bottom of the chart’s price action acted as a sort of price ceiling and price floor for shares of ALSK, and with the stock just starting to make another bounce off of support that day, we jumped on board, buying shares on November 24.

Because the stock was in a trend channel, we had a pretty well defined price target: the upper black line. If the trade played out as planned, we’d have expected gains of around 10%. But we also opted to buy options to maximize our gain potential.

I recommended buying the January 2011 $10 Calls on ALSK for 65 cents, contracts that gave us the option to buy shares of the company for $10 if we held to expiration. With shares already at $10.43, we were only paying a tiny premium on the options, but had significant upside if our trade panned out as planned.

And it did… Here’s what ALSK’s chart looked like after the trade, with our same trend lines drawn in:

While the stock gained around 10% during our holding period – nothing to scoff at in less than a month – our options trade ultimately rocketed to $1.30 by the time my sell alert reached Penny Momentum Trader subscribers’ inboxes; a 100% gain in 20 days.

So, how can you easily make similar trades for your own portfolio?

If you’re new to technical analysis, start to look for well-defined trend lines whenever you look at a stock’s chart. When you do spot an uptrend, wait for a pullback to trendline support (the line that acts as a sort of price floor for the stock) before thinking about becoming a buyer. Then, consider skipping the stock and going right for its option.

It’s essential to remember that options are much more volatile than stocks, so if your trade turns out to move against you, you’ll be down much more than the stock would be. Again, the corollary is that gains on successful trades will be much larger with options…

When selecting call options for a penny stock, you’ll want to pay special attention to trading volume. Because penny stock options are so thinly traded (if available at all), you’ll want to stick with strikes that have large open interest and frequent volume – that’ll assure that you can easily enter and exit the option if you decide not to hold until expiration. And it’ll also ensure that it’s priced appropriately.

If the idea of trading options is new to you, I strongly recommend you “paper trade” for a while to get a grasp of the concepts without putting your money on the line. This strategy could lead you to some real-world profits as we approach 2011…

Cheers,
Jonas Elmerraji
Penny Sleuth

December 21, 2010

Use Options to Supersize Your Penny Stock Gains was originally featured in the Penny Sleuth.

That kind of talk is just plain dangerous.

Don’t get me wrong — I love the fact that more people are discovering the profit potential of options. I’ve been analyzing them for a long time. And since 1999, I’ve been recommending specific option plays for the subscribers of my Options Hotline service.

But despite our success at Options Hotline, I would never be naïve enough to call my work “investment advice.” When you’re dealing with options, you shouldn’t use the word “investment” at all. It’s speculating. And if you don’t understand the difference, you’re setting yourself up for a massive failure.

You “invest” in things like stocks, bonds, mutual funds, and even real estate. You focus on the long-term. Successful investing is like planting acorns and watching them turn into oak trees.

Speculating, on the other hand, is like playing with fireworks on a rainy winter’s evening. You light the fuse, and seconds later, it has either fizzled out or a huge colorful explosion high up in the sky has illuminated the whole world.

Options trading may sound like gambling. And for people who don’t know what they’re doing, it usually is. But seasoned traders know how to bend the odds in their favor. Doing that means having a healthy respect for a speculator’s best friend — and worst enemy — leverage.

Leverage is the magic that turns small price movements into large profits…or losses. It is found in many different guises, but the fundamental design is always the same. The leveraged speculator uses OPM (Other People’s Money) in an attempt to make more money than would otherwise be possible with nothing but his own funds. In other words, you augment your position with borrowed money.

It sounds dangerous…and if not managed prudently, it can be bad for your wealth. BUT, if leverage can be applied to situations with strictly limited risk, it takes on a more sensible aspect. It becomes…”super-leverage.”

Super-leverage is the art of profiting from changing prices, with limited risk. No margin calls, no demands for additional funds, no forced liquidations.

The instruments of super-leverage are exchange-traded stock options.

Options are tradable contracts that give you the right to buy or sell a specific underlying instrument at a specific price within a specific time period. For example, a May $100 Apple Computer call option gives the option-buyer the right to buy one share of Apple Computer for $100, anytime between now and option expiration on May 18, 2007. Today, with the price of one Apple share at $100.80, the June $100 call option costs $2.60. So for under $3.00, an option-buyer can participate in the upside of a $100 stock…but only until May 18.

That means a small move in Apple’s stock price can create a huge move in the price of the call option. In fact, that’s exactly what has happened over the last few trading days. Since April 19, Apple stock has jumped more than $10 a share, for a gain of nearly 12%. But over the same timeframe, the May $100 call option has gone from 75 cents to $2.60 — a gain of nearly 250%. That’s leverage!

But on the downside, options are wasting assets. They have strict expiration dates. If, for example, Apple Computer shares close below $180 on May 18, the May $180 call options would expire worthless. That is your risk.

It was once calculated that 90% of all options expire worthless. But that doesn’t mean you have a 90% chance of losing money. A successful options trader will offset eight or nine losers with one or two spectacular winners…and still have money left over. The trick to always coming out ahead is to develop a strategy and stick to it.

My dad, legendary options trader Paul Sarnoff, explained it best: “Every trader with imagination and talent goes into a specific commodity armed with a trading plan.” With his help, I developed a system I call my “Complete Game Plan for Trading Success.” Followed correctly, it can be a powerful tool to make sure you don’t get in over your head.

It starts with some simple calculations. Just ask yourself the following questions before you risk a single cent:

1. How much am I willing to pay for the option? As I said, you can lose 100% of the money you put into an option. So never bet more money than you can afford to lose. Once you’ve set your limit, stick to it. Don’t chase an option that’s more expensive than you want to pay. Either wait for the price to drop, or look for another one to buy.

2. What will I do if I’m right? Have a profit target in mind for each option you buy, and an idea of how long the move will take. Be realistic — what you honestly think will happen, not what you hope will happen. (If you can’t do that, don’t buy the option.) Again, stick to your plan — give the option some time to reach your goal. If you meet your goal, either sell right away or watch the option carefully and sell before it falls.

3. When will I get out if I’m wrong? This one’s tough. No one wants to admit they’re wrong. And everyone hopes they’ll eventually be proven right. That kind of thinking might fly in the face of stock investing — but when speculating with options, you’re up against the clock. The best thing to do is set strict stop-loss strategies — i.e., orders to sell if the option falls to a certain price. Getting out of a bad position before it’s too late is one of the world’s most overlooked wealth-protection strategies.

You should always speculate based on what you can lose, not what you can gain. Be prepared to handle trading losses. Never add to a losing position. That is how many players get knocked out of the game. You want to be in there when the market goes your way. You, or your broker, must monitor your positions closely. They don’t ring a bell when it’s time to get out, so make sure you have an exit strategy in place for each trade.

It may sound like a lot of work — but believe me, it’s worth it. I’ve seen options skyrocket 210% in three weeks… 472% in less than a month… even 260% in eight days…

Of course, I’ve also seen a good number of trades go nowhere. But following the Complete Game Plan for Trading Success, the odds are good you’ll still come out ahead.

Just never make the mistake of thinking that you’re “investing.”

Sincerely,
Steve Sarnoff
October 18, 2007

P.S.: If you are interested in the unlimited potential of these kinds of “speculations,” then you are in luck. My publisher has given me the chance to give away six free months of my options service, Options Hotline. So be my guest, check out this free report explaining it all to see how you too can pull in profits of 165%, 220% and even 300%, just like my current readers have

Investing with Options Plays was originally featured in the Penny Sleuth.