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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Cheers,

Jonas Elmerraji
for The Penny Sleuth

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

Here’s what you need to know:

Rule 1. Write Your Own Risk Level

Understanding risk is one of the most important elements of investing in anything — from penny stocks and options to commodities to currencies — no matter what, you need to enter each trade knowing exactly what’s at stake when you trigger your trades.

Risk is inherent in all investments (don’t believe anyone who tells you otherwise). But risk isn’t necessarily bad.

You see, risk and reward are interrelated. Higher-risk investments, like penny stocks, obviously come with greater chance of loss, but they also have the potential for much larger gains if trades go our way. The trick to successful trading is managing risk intelligently…

So, how do you reign in risk? I always set mental stop loss levels and potential target prices before I trade any stock. To do that, you need to add some basic technical analysis to your investment strategy.

Stops can be very useful when they’re placed under a stock’s support level (the price level that a stock has trouble falling below). That’s because to a trader, a price level below support generally means that the stock could be breaking out much lower. Essentially, you’ll want to place stops just under where you’re likely to find a glut of demand for shares.

To avoid exceeding your comfort zone on a loss, think of your “maximum pain threshold” as a dollar amount rather than a percentage. Then, size your position so that you’re stopped out before your losses exceed that level. Trailing stops, which are typically used to lock in gains, can be used a little bit more arbitrarily.

Ultimately, your risk tolerance is up to you. But regardless of how aggressively you opt to trade, there’s a potentially lucrative option available to you…

Rule 2. Don’t Chase Trades

Sometimes, you won’t be able to act on a trade in time. Maybe you’re on vacation and away from a computer when a nice setup pops up. Maybe you’re stuck in a meeting. Whatever the case, if you miss out on a trade, it’s essential not to chase it.

Trading is exciting. Part of what draws traders to playing the market is the thrill of executing a trade and cashing in on gains — it’s that adrenaline rush that keeps things interesting.

But on the flip side, it’s all too easy to get into a trade at a bad time just because of the excitement of seeing a stock start to run up. When a trade triggers, it’s crucial not to buy into the frenzy that often comes with a breakout. Instead, set you maximum buy price ahead of time, when you’re weighing the risk/reward tradeoff of a particular setup. Sometimes that’s a tough edict to swallow — especially when hindsight shows you what would have been a winning trade. But emotion has no place for traders. Don’t fall for the irrational exuberance of a late trading opportunity.

Rule 3. Buy the Right Number of Shares

Do you know how many shares of a stock you should buy? Don’t guess — the number of shares you buy has everything to do with how much profit you take home…

With (normally) flat costs like commissions taking a bite out of your trading profits, you need to make sure that the position sizes you’re taking are enough to make up for your commission fees. If you buy a $100 stake in a small-cap stock, with a $10 commission each way (when you buy and when you sell), your break-even gain becomes 20%. That is, you’ll need 20% gains just to avoid posting a loss. That’s a sizable challenge.

If you buy a $500 stake, however, your break-even gain drops to a much more manageable 4%. If your commissions are only $5 per trade, then your break-even tumbles even further down, to 2%.

Always know what kind of gains you need to see to profit from a trade before you place an order with your broker. Again, this ties back into our first rule, writing your own risk level. By focusing on low-risk trades, you can afford to take on larger positions while maintaining the same level of risk – and as a result, you’ll take home bigger gains every single time.

I’d recommend you save this message. Then, before you click the “buy” button on your brokerage account, keep these three rules in mind. Follow them, and you’ll guarantee yourself bigger gains…

Cheers,

Jonas Elmerraji

3 More Rules That Guarantee Gains was originally featured in the Penny Sleuth.

You don’t have to be a professional trader to take advantage of this set-up. You can even use the pattern I’m about to show you even if you know next to nothing about technical analysis. All you have to do is recognize the key features and respond to the pattern’s clear buy and sell signals.

The pattern I’m talking about is called a trend channel. A channel is easy to spot. It consists of a trending stock flanked on either side with a high and low range. In our example, the high range (resistance) is marked by a red line. The low range (support) is marked by the blue line:

Buying channeling stocks makes perfect sense right now. All of the important ingredients are in place to execute a successful channel trade.

First, the market is trending higher. It’s always in your best interest to take the path of least resistance when trading. So if you’re planning to go long, you want the overall trend moving in your favor. Since stocks are generally moving higher this year, trading a rising channel will sync your buying with the broad market.

Next, the recent pullback has expanded your trading options. The best time to buy a channeling stock is when it bounces off the lower end of its trading range (the blue line in our example). As the market retreats from overbought levels, many of these channeling stocks have followed suit. With more prices testing channel support, you have a variety of channeling names that are flashing buy signals right now. Buying a stock as it perks off support is an ideal low-risk trade. If support fails to hold, you can exit the trade with minimal damage to your account.

Finally, a stock trending higher in a channel could be setting up for an even bigger move. A stock that is exhibiting a channel pattern is already trending higher. But if the stock breaks above resistance (the red line in our example) the uptrend could accelerate. Old resistance becomes new support, and the stock moves even higher. Using the channel, you would have been able to time your buy perfectly to maximize your gains.

As you can see, one of the main benefits of channeling stocks is that they give you clear-cut buy and sell signals.

Channels are also useful for traders with different goals…

Take a look at the buy and sell points noted with the arrows on our next chart. If you’re a trader who is comfortable using shorter timeframes, you can use the channel to make multiple trades. You can buy at support (blue arrows) and sell at resistance (red arrows), taking profits along the way. Or, if you prefer to hold positions for a longer timeframe, you can act on the initial buy signal, and hold the stock for the duration of the trend.

You don’t need any fancy pattern recognition software to find the perfect channel trade. You can go to virtually any free online stock screener tool to search for your trade candidates. It can be as simple as searching for stocks within 5% of their 50-day or 52-week high. Or, you could search for stocks that are trading above their short, medium, and long-term moving averages.

The key is finding stocks that are trending higher. Then, it’s just a matter of scanning the charts and finding the best looking channel setups. No matter how you search, you should have no problems finding low-risk, high reward channel trades.

Sincerely,

Greg Guenthner
for The Penny Sleuth

3 Reasons to Buy “Channeling” Stocks was originally featured in the Penny Sleuth.

Earnings Season May Challenge U.S. Stocks

…Survey Indicates Stock Market Rally About to End

Much of US stock rally might be over for 2012

Are we getting a common theme here? Seemingly out of the blue, investors are expecting the market to top in April. But I’m not buying it — and you shouldn’t either…

There’s nothing the financial media loves to do more than react to the market. Unfortunately, it’s not just the financial media that loves to do it; so do the talking heads that grace TV news and opine about Mr. Market’s innermost feelings. Looking at the news coverage of the stock market in the last couple of weeks, it feels like stocks have pulled back pretty dramatically, right?

If you look closer, you’ll see that it’s not the case. People are just reacting to a couple of days of stock selling:

Yes, stocks have slowed down a bit in the last few weeks, but let’s not forget that we’re coming off the heels of the best first quarter for stocks in more than a decade. And while the S&P 500 has pulled back in the last couple of weeks, it’s not flashing any sell signals just yet.

Looking at the S&P’s price, there are a couple of things that should stand out first and foremost. One is that the latest pullback hasn’t exactly been the “massive selloff” that the media has been exclaiming — the market is merely trading sideways.

The other is that the primary uptrend in the S&P is still intact. We’re testing trendline support right now, but this trendline has already withstood three other major tests since the rally started.

Another metric worth watching is the 14-day RSI graph at the top of the chart. RSI stands for Relative Strength Index — it’s a measure of momentum. Although momentum has been declining in the very short-term, we’re coming in within a few points of the neutral 50 level in RSI right now. The last time we hit 50 was back in March, just as the S&P started on the second leg of its rally…

And you guessed it, scores of investors were sure that we’d hit a 2012 top back in March too.

At this point, the technical outlook of the S&P 500 still looks cautiously optimistic.

It’s way too easy to let emotion rule your trading in markets like this. That’s why it’s crucial to keep looking at the market’s most recent moves in context. Don’t get caught up reacting to the last few trading days. Looking at a four to six month chart of the S&P 500 at the start of every trading week is a good way to avoid getting caught up in the media’s echo chamber.

You can pull up a free, live copy of the chart I showed you by visiting StockCharts.com There, you can annotate and analyze the chart to your heart’s content. I’d suggest bookmarking the page — it’s worth referring back to each Monday to get a clearer picture of what’s happening on Wall Street.

Cheers,

Jonas Elmerraji
for The Penny Sleuth

Why The Rally Isn’t Over… Yet was originally featured in the Penny Sleuth.

Wait, what the heck does that mean?

Resistance is one of those words that gets thrown around a lot by market professionals without much thought about whether or not most people really know what it means. I’ll admit that I’m guilty of that too. But today, I want to take a minute to explain exactly what resistance means in real terms — and show you a real-world resistance trade I just made with my premium readers to take home gains of 12.7% in less than a month.

Put simply, resistance is a price level that a stock has difficulty moving up through. In other words, it’s a “price ceiling” for shares. It only takes a minute to spot a resistance level on a price chart — you’re just looking for a price that shares consistently move up to then bounce lower off of.

At the end of the day, prices all come down to supply and demand. Resistance levels work because they’re prices where there’s a glut of supply of shares. They’re prices where sellers become more eager to sell than buyers are to buy. And as a trader, a stock’s behavior around a resistance level can have some big implications…

If a stock “breaks out”, and pushes above resistance, we know that buyers have absorbed all of that supply of shares that was causing the price to act like a barrier. Without that barrier, there’s room for shares to move higher. That’s why a breakout is a buy signal.

So, let’s take a look at a real-world example of a breakout trade that my Penny Momentum Trader readers just had a chance to book 12.7% on in the last month…

The stock in question was Charming Shoppes (NASDAQ:CHRS), a small-cap apparel stock that had a long-term resistance level just above $5. Try as they might, shares hadn’t been able to push above $5 for the better part of a year — that’s exactly why a breakout above $5 was such a big deal.

The video below is the analysis that I sent my readers back in February:

Shares shoved their way above $5.05, and we pulled the trigger on the trade on February 6. By March 1, shares had reached our price objective and we took gains of 12.7%. Along the way, this stock demonstrated an important characteristic of resistance levels: the fact that they become support levels — or price floors — once they’ve been exceeded.

All told, the completed trade looked like this:

Now that stocks are back in sustained rally mode, it’s becoming easier to spot tradable resistance levels in the market. That means that you can put this simple technique into practice to find profitable trades of your own — it’s as simple as bringing up a candlestick chart at a site like StockCharts.com, and looking for resistance levels in a handful of stocks.

Happy Trading,

Jonas Elmerraji
for The Penny Sleuth

Chart Smarts: The Importance of Resistance Levels was originally featured in the Penny Sleuth.

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.