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.

But it doesn’t have to be that way…

Today, I’d like to show you four simple chart patterns that could help you find your next profitable trade in 2012.

In his book, The Definitive Guide to Point and Figure, Jeremy du Plessis argues that:

“Some authors go on to list tables of patterns, but the need to learn patterns indicates a lack of true understanding of how a pattern is created. There is no point in trying to learn dozens of patterns; it is better to understand what causes them.”

As a market technician, that’s one of my favorite quotes. When it comes to chart patterns, it’s absolutely true that rote memorization will only get you so far. Instead, it pays (literally) to understand how and why patterns are created.

At their most simple construction, patterns are just different arrangements of support, resistance, and trend lines. While I won’t get into too much detail over how those individual building blocks work, you should be able to see a lot in common with the four patterns I’m about to show you. So, rather than trying to memorize the pattern on these four formations, memorize the combination of support, resistance, and trendlines that combine to create them…

1. Ascending Triangle

First up is the ascending triangle, a bullish pattern that’s formed by a horizontal resistance level to the upside, and uptrending support below shares. Those two technical levels form a shape that resembled a right triangle. As shares bounce in between them, they get squeezed closer and closer to a breakout above that resistance level. When the breakout happens, it’s a strong buy signal for shares.

The bearish opposite of the ascending triangle is a descending triangle. In a descending triangle, shares have horizontal support and downtrending resistance. The shorting signal comes when that horizontal support level gets broken.

2. Head and Shoulders

One of the most well-known technical formations is the head and shoulders top. It’s a bearish pattern that’s identified by a peak (the head), with smaller peaks on each side (the shoulders). Even though the head-and-shoulders is likely the most well known technical pattern, it’s still a valuable one: an academic study conducted by the Federal Reserve Board of New York found that the results of 10,000 computer-simulated head-and-shoulders trades resulted in “profits [that] would have been both statistically and economically significant.”

On the opposite side is the inverse head and shoulders, which, as the name implies, is just a flipped version of the head and shoulders top. It’s a bullish pattern.

In both cases, the trade signal comes when shares push through the neckline (sometimes called “shoulder level”) in the chart above.

3. Consolidation

A consolidation channel (sometimes called an “If/Then Trade”) is a channel that’s bounded by both a horizontal resistance level and a horizontal support level. Frequently, consolidation channels come after large moves. They’re an opportunity for a stock to bleed off some volatility and for traders to think about their next moves. Unlike the other patterns we’ve looked at, this setup doesn’t have any directional bias until it triggers.

The trigger happens when shares push outside of the channel. When that happens, the high probability move is to take a position in the direction of the breakout.

4. Double Top

Finally, we’ll look at the double top; as the name implies, it’s a topping pattern (thus it’s bearish). The double top can be identified by two swing highs that peak at approximately the same price level — that price level is a strong resistance level, above which there’s a glut of supply of shares that overwhelms buying pressure. A double top becomes a short signal when shares push through the intermediate trough that separates the tops.

Not surprisingly, a pattern called a double bottom is the bullish opposite of the double top.

While we’re hardly taking an exhaustive look at all of the potential patterns that you may encounter in the market, these four patterns provide a good sample of how the building blocks of support, resistance, and trend create actionable patterns. By keeping these four patterns in mind the next time you look at a chart, you’ll be better able to spot other, more unconventional setups than traders who resort to rote memorization.

Happy trading in 2012,

Jonas Elmerraji
for The Penny Sleuth

Learn These 4 Profitable Chart Patterns was originally featured in the Penny Sleuth.

It’s true that volatility measurements remain well above historic averages. However, the volatile action that has plagued stocks and baffled traders over the past 6 months could subside at some point this year. That means market conditions could become much more favorable to traders. Clearer entry and exit points will materialize when higher periods of volatility subsides — and fewer whipsaws will force traders to cut early losses.

Unless you’ve been living under a rock for the last year, you’ve probably noticed the huge volatility that’s been shoving the stock market in one direction then the other. What you may not have realized is the fact that individual investors aren’t the only ones affected: “…traders who used to profit from price swings are struggling as record stock market volatility shows no signs of abating,” read a recent article in Bloomberg Businessweek.

While the final numbers have yet to roll in, hedge funds are looking to post their second-worst year in history after volatility has knocked around a number of high-profile funds. Victims include John Paulson, who made $5 billion in 2008 by betting against the housing market, and Duke Buchan, whose billion-dollar hedge fund is shutting its doors after coming into the year ahead of stocks by 46% in the last decade. No one has been immune from 2011’s wild ride.

Quite frankly, I haven’t been immune from the volatility either. While my premium trading service’s portfolio booked an average closed gain of 5.39% held over 20.2 days in 2011, that performance number came in well shy of the 19.27% average gain we took home in 2010. While it’s great to beat most investors, it’s still frustrating to trade in this sort of environment.

And it looks like that will remain the case for the time being…

The chart above shows the Bollinger Bandwidth for the S&P 500 — this indicator is a statistical measure of volatility that’s a much less biased measure than popular volatility measures like the VIX. Bandwidth has been inflated lately, rising to a nearly three-year high as recently as mid-September, and remaining above its historical average now. For that reason, it makes sense to expect volatility to remain a factor.

But there is a silver lining to the volatility story we’re seeing right now. You see, market volatility is cyclical — in other words, markets oscillate from periods of high volatility to periods of low volatility.

Looking at the bandwidth chart, it’s clear that volatility has been on the downswing since those September highs.

As a result, I think that we’ll see a return to more normal levels of volatility at some point this year. Although we’ve only seen a handful of trading days in 2012, volatility is already measurably lower. Because of the abrupt drop in volatility, it’s quite possible that a volatility squeeze could pop price action back into swing mode in the near term.

As a trader, you should be watching indicators like Bollinger Bandwidth, not the calendar, to signal calmer waters in 2012. While most high-end charting packages let you apply the indicator, free services like StockCharts.com also enable investors to take a look at the market’s Bollinger Bandwidth with just a few clicks of a mouse.

If volatility does indeed subside in the near future, you should have a much easier time identifying a variety of promising trade setups.

Cheers,

Jonas Elmerraji
for The Penny Sleuth

Why Stock Trading Could Get Easier This Year… was originally featured in the Penny Sleuth.

Most people’s New Year’s Resolutions lists feature the standard self-improvement plans for 2012: lose weight, quit smoking, and travel more. But as a trader, your list of resolutions should look a little bit different. Today, I want to show you a common setup that you should plan on trading this year.

You may have already heard of the ascending triangle, but it’s worth taking a look at this technical trading pattern from a fresh perspective. Not only is it one of the most common trading setups I come across, it’s also one of the highest probability trades on the market if you approach it correctly.

To fill you in, let me walk you though a real life trade that I recently recommended to my small group of members.

If you weren’t already aware, I run Penny Momentum Trader, an elite-level trading research service that issues specific buy and sell recommendations based on technical analysis. On November 2, a textbook ascending triangle trading setup popped up on my radar. I sent the chart below to my readers, and told them to put Raptor Pharmaceuticals (NASDAQ:RPTP) on their watch list.

You can watch the analysis video that I sent readers by clicking on the image below…

11-2 Watch List: RPTP from Agora Financial on Vimeo.

As you can see in the chart, an ascending triangle is a trading setup that sports a horizontal resistance level (in this case, $5) and uptrending support. Essentially, as shares bounce between those two key technical levels, they get squeezed closer and closer to a breakout above $5. That breakout is crucial because it tells us that buyers have regained control of the market for RPTP, and absorbed the glut of supply that had held prices below $5 for so long.

It’s important to note that the chart I sent wasn’t a buy signal in and of itself — actual trading signals don’t come when you spot the ascending triangle pattern. Instead, the buy signal comes when the breakout above $5 happens…

In the case of RPTP, that breakout came on November 30, and I sent out a buy alert to PMT readers that morning suggesting that they buy either shares of RPTP, or a specific call option that had a higher risk/reward tradeoff. Our price target was just above the $6 level.

So, how did the trade pan out?

We hit our price target seven days later, on December 7, and I sent off a sell alert. All told, readers had a chance to book gains of 13.4% on shares of RPTP and more than 43.8% gains on the options recommendation — all in just a one-week holding period.

Even though 2011 was a tough trading year, there were opportunities to squeeze profits out of Mr. Market if you knew where to look. In 2012, I expect that we’ll see a similar environment for the early part of the year — that’s why it’s so crucial to be aware of the trading setups that can actually provide your portfolio with gains in this sort of market. The ascending triangle may be a simple setup to spot, but it can offer up some powerful gains.

Watch out for the ascending triangle the next time you’re looking at charts.

Cheers,

Jonas Elmerraji
for The Penny Sleuth

Chart Smarts: How to Make 44% Gains on This Trade was originally featured in the Penny Sleuth.

The strategy was relatively simple: short sell momentum stocks as they begin to show signs of weakness. In 2011, we saw a changing of the guard. Several prominent momentum names — even market leaders — had various weaknesses exposed and exploited by short sellers. Keep in mind that these are household names — many of which were considered can’t-lose investments since the 2009 bull rally began.

Every single one of these high-flying stocks had a distinct breaking point. Once the investing public began to turn against them, the inflated valuations would no longer stand up to scrutiny. What resulted was a death spiral that mutilated every buy-and-hope investor in the market.

The momentum meltdown could very well continue into 2012. Several market leaders, including Apple Inc. (NASDAQ:AAPL) have showed signs of weakness lately. And while it’s not a short opportunity just yet, we could continue to see additional investor favorites bite the dust during the new year.

To help you spot these opportunities, let’s review the signals that set up some of this year’s biggest shorts:

Netflix Inc. (NASDAQ:NFLX): Netflix was the most prominent stock to fall from grace this year by far. Up until June, this was the best performing stock in the U.S. since the markets bottomed out in March 2009. Sadly, due to numerous subscriber pricing miscues and what later turned out to be complete managerial incompetency, the company that bankrupted Blockbuster and held a virtual monopoly on paid movie and television streaming completely fell apart.

From a high of almost $305 per share, the first sign that something was very wrong came in late July when the long-term uptrend was broken on the weekly chart. Market weakness exacerbated the plunge, helping shares lose more than 75% of their value since the summer highs:

Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR): Coffee stocks — a group that includes Green Mountain and several sympathy plays — were one of the hottest investments on Wall Street earlier this year. For the first half of 2011, shares of GMCR soared from $32 to a high of $115 by September.

But outrageous growth projections eventually got the better of GMCR, sending shares briefly below $40 by the start of November. As you can see from the chart below, GMCR first broke below its accelerating trendline (dotted blue line) in September. For more conservative traders, another short opportunity presented itself last month when shares violated the longer-term trendline:

Sodastream International Ltd. (NASDAQ:SODA): Sodastream is an intriguing company, which is one of the main reasons the stock became so popular in 2011. As consumers began touting the benefits of the company’s at-home carbonation systems, the stock began to take off. Unfortunately, it has yet to recover from the August correction. Shares remain more than 50% off their highs:

As 2012 approaches, keep an eye on potential momentum breakdowns that mirror these patterns. They could end up being some of the best plays of the year…

Sincerely,

Greg Guenthner
for The Penny Sleuth

Momentum Meltdown: The Best Trade of 2011 was originally featured in the Penny Sleuth.

But don’t fall for the bounce in stocks today… for reasons I’m about to explain, Santa’s not coming for investors this year.

Wall Street has an attribution problem. Investors see a big pop in stocks, and they look for the nearest headline as a reason for the move. By that logic, it makes sense to attribute today’s 3% gain to retail sales and hopes for a European fix — but that’s not what’s happening here.

Instead of looking at headlines, let’s look at price action. As of Friday’s close, stocks had moved lower for seven consecutive days, a statistically improbable losing streak for the broad market. At the same time, the size of the drawdown in stocks was important; month-to-date, stocks have shed 7.55% in November. That’s the second-worst November in a decade. So it’s no great shock that stocks are showing us a relief rally this morning. Statistically, Mr. Market was very likely to bounce back hard this week.

But if today’s bounce in stocks is bogus, where does that leave investors as we approach 2012?

As I see it, two major factors are going to dominate trading for the rest of 2011: the technical breakdown in stocks and Europe’s inability to get anything done.

This chart of the S&P 500 gives a pretty good technical picture of what’s going on in the market right now:

Last week’s price action shoved the S&P 500 (our best proxy for the broad market) back into the price channel that had constrained shares for much of the late summer. That means that for stocks to move back to positive territory for the year, they’ll have to surmount a newfound resistance level at 1225, a price ceiling that makes more sideways volatility the most likely scenario to end 2011.

So while today’s upward move is significant from a percentage standpoint, it’s an “easy move” through neutral space. As supply and demand for stocks stand now, it’s very unlikely that we’ll see equity prices push back above that channel before the end of the year.

I’m not saying that we’re doomed for another major crash right now. Instead, it’s likely that we’ll just see volatile churning within the channel — after all, a major pocket of demand exists below the 1100 level in the S&P 500. As long as stock prices stay stuck below resistance 1225, it’s not going to be favorable to be a buyer.

The second big factor affecting stocks this month is Europe. In fact, Europe has managed to take the wind out of investors’ sails every time stocks seemed to be turning higher in the last quarter — and there’s no reason to think that that’ll change in December.

Investor sentiment toward Europe is turning higher today thanks to a report that eurozone leaders had reached a new pact to solve the crisis, including an IMF bailout of up to EUR 600 billion for Italy. But investors are ignoring the fact that Greece, the country that started the whole mess, is asking investors to take bigger losses on its bonds than initially agreed upon.

If the success in negotiating Greece’s debt crisis is unraveling, why is the market celebrating the new debt deal being forged across the pond?

Until the constant threat of a budget meltdown in Europe and at home gets resolved, investors are going to be held hostage.

That’s why, at this point, it doesn’t look like Christmas is coming for stock investors this year. With more sideways churning likely to take us to the end of 2011 (and a bit beyond), it makes sense to reduce your exposure to the broad market and stick with safety assets until stocks break back outside of the channel.

Cheers,

Jonas Elmerraji
for The Penny Sleuth

Why Santa’s Not Coming for Investors This Year was originally featured in the Penny Sleuth.

Stocks have pushed substantially higher in the last week, buoyed by positive early earnings data on Wall Street and “upbeat” news coming from Europe. Despite the frenzied buying that investors are participating in right now, it bears repeating that you shouldn’t trust this rally just yet.

The biggest problem with the positive push in stocks is the fact that the S&P 500 is still sitting in the consolidation channel that we’ve been watching for some time — this isn’t the first time that stocks have tested these levels.

More importantly, the lack of breakouts right now speaks to the diminishing market breadth that we’re seeing as this rally pushes forward. In a healthy rally, we’d normally expect to see a number of stocks pushing through resistance levels — the fact that they’re not suggests that this rally is made up of “easy moves” right now.

Another concern is the decline in volume as the rally has progressed. That sort of a negative divergence indicates a lack of participation among investors. We’ll obviously want to see those issues reconciled before we buy into this rally. I’ve mentioned before that solid earnings could be just the catalyst to break us out of these extended summer (and now fall) doldrums.

Our best indication of a more sustained breakout comes if the S&P can hold itself above 1,225. Until then, being a buyer is a comparatively high-risk move. So, what should you be watching for next week? Here’s a quick rundown of the three most important factors that’ll help to shore up this anemic rally…

1. Earnings Performance

Earnings — or the lack thereof — have been the biggest reason why stocks have been left flapping in the wind lately. Without any sort of fundamental backstop for share prices, stocks have been looking “cheap” for a while now. Now that earnings season has officially kicked off this week, we could be closer to a scenario where solid corporate earnings catalyze a more forceful bull run.

Good earnings don’t guarantee a rally. It’s important to keep in mind that the past two consecutive quarters showed Wall Street earnings that dramatically outpaced analysts’ expectations — all told, 75% of S&P 500 constituents have posted positive earnings surprise in 2011 — but it’s still been a rough market this year. It’s not the earnings themselves that matter for prices so much as investors’ reaction to those earnings numbers.

If we start to see stocks get bid up on fairly decent data, we can assume that this rally is getting legs.

2. European Stability

Europe’s debt crisis has been one of the biggest forces dragging U.S. stocks lower. That shouldn’t come as a huge surprise, after all, the eurozone as a whole is our largest trading partner, and weakness in the euro translates into earnings weakness for the bevy of multinationals that make up the majority of the equity market here at home. The interconnectedness of our financial markets means that a debt-induced collapse of European banks would have big ramification here at home…

That’s why it’s so crucial that some sort of a meaningful tourniquet be placed on the eurozone in the near-term. Good news from across the pond should help to stabilize the rally.

3. A Breakout in the S&P 500

From a technical standpoint, the most important factor to watch is price. In the near-term, a breakout above the 1,225 level in the S&P 500 is the broad market signal that there’s strength in stocks right now — that’s because 1,225 has acted as a sort of “price ceiling” for shares in the past, restricting the market’s movement both of the last two times the S&P approached that level.

Because there’s currently a glut of supply above 1,225, a breakout above that resistance level indicates that there’s sufficient demand to overcome sellers — and it means that stocks aren’t just making the easy moves. I’m not just talking about one tick at 1,225; the S&P will need to stage a confirmed breakout above that level for it to be significant.

On an individual stock basis, breakouts in small-cap stocks are likely to lead a breakout in the S&P 500.

Keep these three factors in mind next week, and you’ll be better-prepared to take low-risk, high probability positions in this crazy market.

Cheers,

Jonas Elmerraji
for The Penny Sleuth

3 Things We Need to See Next Week to Be Bullish was originally featured in the Penny Sleuth.

The rally began more than a week ago as stocks surged from the brink of new lows to impressive gains just before the closing bell. Since that day, stocks have barely paused, recording gains in five of the past six trading sessions.

However, I will be the first to admit that I remain skeptical of this rally. As much as it has been exciting (and relieving) to see stocks recover some of their losses so quickly, my mind remains in bear-market mode. Anyone looking to go “all-in” right now — while the market is overextended in the short-term and the primary trend is in flux — does so at his own risk.

Here are three things I’ll need to see over the next several days…

Small stocks need to break downtrends — If you were perusing microcap charts recently, you probably noticed a lot of V-shaped bottoms. Many of the stocks in the small-cap and microcap trading universe have established sharp downtrends since the beginning of the market correction two months ago. Obviously, this makes for dangerous trading ground for those of us looking to go long. A sharp break to the downside could easily wipe out any gains most of these stocks have posted over the past week. I want to see clear, convincing breakouts from downtrends before going long here.

Also, keep in mind that most of the small stocks posting double-digit gains during the most recent rally have been benefiting from being scooped up off extremely oversold levels. This type of buying rarely lasts unless the stock clears significant resistance levels, and I don’t recommend latching on to these names in an attempt to play them as a momentum trade. The timing has to be perfect if you want to bank significant gains, and most of the plays are far too risky to warrant consideration for a swing trade.

The market needs to move higher on bad news — In particular, I would love to see stocks shrug off universally bad news out of Europe. If stocks can move higher when the headlines are negative, you can be close to certain that there has been a drastic change in market sentiment. After all, it’s easy to expect a rally when bullish news is flying across the wire. When market participants begin to “believe” that prices will move higher, there’s little that can stand in the way of the bulls.

The Russell 2000 has to hold its ground —

I like how the Russell has popped above its 50-day moving average. The small-cap index will need to either consolidate or move higher from here to convince us that the downward momentum has stalled.

Sincerely,

Greg Guenthner
for The Penny Sleuth

Back From The Brink? was originally featured in the Penny Sleuth.

Practical advice — the tried and true suggestions like “buy what you know” and “invest in value” — are great strategies much of the time. They’re investment philosophies that have historically made folks a lot of money in the stock market. But it’s time to ditch them now.

I realize that sounds crazy, but let me explain…

Following the practical advice in 2011 as a buy-and-hold investor would have earned you negative returns approaching 10%. But the solution hasn’t been to bet against stocks either. Stocks have produced wild swings that have made it just as difficult to be short in this market. That volatile up and down action means that from a psychological standpoint, both longs and shorts are feeling pain right now.

Forget practical. Instead, it’s time to be tactical in this market.

Being tactical means taking your trading cues from the market technicals rather than getting them from company fundamentals. After all, years like 2008 remind us that stocks can continue to sell off even if the fundamentals behind them haven’t changed. To be clear, I’m not advocating throwing away fundamentals altogether — instead, I’m recommending that you ignore them until Mr. Market takes his anti-psychotic medication again.

Macro technical factors can tell us when it makes sense to add those practical investment strategies back into the mix — but right now, they’re telling us to trade tactically.

So, how can you “get tactical” with your portfolio right now? To start, you’ll need to think about your portfolio a bit differently, especially if you’re not familiar with technical analysis. The first step is to understand the dangers of action bias…

Most investors think that you need to be “doing something” all the time. It’s a fallacy called action bias — and it’s one of the biggest reasons why individual investors struggle in markets like this one. Simply put, action bias occurs when traders trade for the sake of trading, rather than to take advantage of a high-probability opportunity in the market. Not surprisingly, action bias adds additional market exposure to your portfolio (aka risk), and that exposure comes in the form of investments that are inherently less good than a regular trade would be.

To fix action bias, you need to remember that a lack of trading signals is a signal in and of itself: it’s a sign that you need to exit stocks and move to cash. It can be frustrating to sit on the sidelines when stocks are showing volatile price action, but it could be one of the best “trades” you make all year.

A perfect example of that comes from Penny Momentum Trader, the trading service I run.

In 2011, we’ve grabbed modest, tactical gains when situations presented themselves, and kept minimal market exposure when they didn’t. Both of the periods we’ve sat with an empty portfolio — briefly back in March, and again sporadically this summer and now — have been periods when longs lost significant value, and shorts that followed got more of the same.

The result is a portfolio that’s actually averaged positive returns this year, even as everyone from trading desks to hedge funds are losing money.

At this point, it pays to think like a trader and not like a “practical investor”. Being tactical — and avoiding action bias — is your best bet to make money even in this market. I’d strongly recommend checking out the Penny Sleuth’s research reports on technical analysis to learn more about the types of trading setups that make sense right now.

I’ll let you know when Mr. Market decides to make up his mind again…

Cheers,

Jonas Elmerraji
for Penny Sleuth

Get Tactical to Keep Your Profits in This Market was originally featured in the Penny Sleuth.

But sound trading strategy can still eke out some pretty significant gains in this market right now. Today, I want to show you a technical trading setup that scored my PMT subscribers 20% gains last week…

In case you’re not familiar, I run Penny Momentum Trader, a small-cap trading service where I make specific trade recommendations to my subscribers. Like every other trader or investor out there, we’ve found the past few months to be challenging — the number of trading opportunities has declined, and this choppy market has been a real psychological test.

There’s a difference, though, between taking on a challenging market and getting shellacked as stocks sell off.

We’ve avoided the lion’s share of losses by being disciplined in our technical strategy — just as important, we’ve also managed to collect some significant gains by being tactical with our trades. While we may not be in a great trading environment, we’re still doing a whole lot better than most right now. And setups like the one I’m about to show you are a big part of the reason why…

Enter Endologix Inc. (NASDAQ:ELGX), a small-cap medical equipment stock that develops devices that treat aortic disorders. Endologix popped up on my radar because of a bullish setup in shares: an ascending triangle. Below is the short video analysis clip that I sent to my subscribers earlier this month detailing the setup:

9-7 Watch List: ELGX from Agora Financial on Vimeo.

You can spot an ascending triangle by its two defining features: a horizontal resistance level that acts as a “price ceiling” for shares, and uptrending support that indicates buying pressures are increasing. As shares bounce in between those two technical barriers, the potential for a breakout to the upside increases dramatically.

The trigger in this trade was simple — we wanted to buy shares on a breakout above that $10 resistance level in shares. Remember, a breakout is more than just share price moving above some line on a chart; instead, it’s a shift in the supply/demand equation for shares of a stock.

Previously, ELGX had seen substantial supply of shares at $10. That’s the price level where shareholders thought shares looked “expensive”, and they wanted to take gains. As a result, $10 had acted as a sort of price ceiling in the past for ELGX. A breakout above that level told us that suddenly, demand was overwhelming supply at $10, and buyers were in control of the market for shares.

Even though the market was still weak, a technical breakout in ELGX was in itself a strong signal that we’d have a good trading opportunity. The key on an ascending triangle (or any other breakout trade) is to wait for the breakout to occur before buying.

Waiting for prices to move higher before buying may seem a bit anti-intuitive (especially if you’re a value investor), it’s the only way to make sure you’re dealing with a high probability trade, not a gamble.

On Thursday, September 15, shares confirmed a breakout above that $10 level and I sent a buy alert to my subscribers, recommending a position in shares (I also provided a higher-risk options trade on the stock). In the alert I said that we had a conservative price target of $11.35 — and a stop loss level at the 50-day moving average. Those two numbers let us calculate our risk/reward right out of the gate.

So, how’d this trade turn out? Here’s an updated look at ELGX:

As you can see, shares rallied almost perfectly to our $11.35 price target before reversing lower on broad market weakness. I sent an alert to take gains of half of the position last Tuesday, locking in gains of 10% on shares and around 20% on the recommended options. Not too bad for less than a week of holding time.

We closed out the rest of the position for a gain a couple days later, as the market reacted poorly to Operation Twist.

Stocks are choppy right now, and frankly, it could be a while before we return to the kind of directional market conditions that traders love. Even so, disciplined trading can protect you from losses and even make significant short-term gains while other investors watch their assets shrink.

Add the ascending triangle to your trading toolbox, and you’ll be better prepared to profit from the next market move…

Cheers,

Jonas Elmerraji
for The Penny Sleuth

Chart Smarts: The Pattern That Made 20% in This Market was originally featured in the Penny Sleuth.