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5 Breakout Trades to Profit From the ‘January Effect' - views
BALTIMORE (Stockpickr) -- Ask five different traders what they think about the "January Effect" for stocks, and you'll probably get five different answers. Call it what you will, though, January looks like it could be setting up to be a strong month for stocks.
And some names look more likely to rally than others right now.
Just a handful of trading days into 2012, the S&P 500 has already climbed more than 4%, pushed its way to within less than a dozen points of a new 52-week high, and started anxious investors wondering whether stocks were so scary after all. Those factors are likely to come into play this month as earnings season adds a dose of fundamental reality to investors' opinions. So far, earnings beats are outpacing misses by a wide margin.
But with most investors understandably fixated on earnings, we're looking elsewhere for trading opportunities today. Instead, we're taking a technical look at five big tradable charts that could pad your portfolio this month.
If you're new to technical analysis, here's the executive summary.
Technicals are a study of the market itself. Since the market is ultimately the only mechanism that determines a stock's price, technical analysis is a valuable tool even in the roughest of trading conditions. Technical charts are used every day by proprietary trading floors, Wall Street's biggest financial firms, and individual investors to get an edge on the market. And research shows that skilled technical traders can bank gains as much as 90% of the time.
Every week, I take an in-depth look at big names that are telling important technical stories. Here's this week's look at the charts of five high-volume stocks to trade for gains.
The bigger they are, the harder they fall -- and that's certainly been the case with Wal-Mart (WMT) over the last few months. Since mid-October, the retail giant has shed more than 11%, a time when the rest of the S&P has actually gained ground. But there's reason to believe that the selling could be coming to an end right now.
Even though the price action in WMT doesn't look particularly promising, it is. That's because while shares are making lower lows and highs, WMT is making them in a formation called a falling wedge. The falling wedge is formed by converging downtrend lines, and despite its appearance, it's a bullish pattern. In fact, one study puts the pattern's ability to spot a reversal at more than 90%.
The buy signal for WMT comes on a breakoutabove the upper trendline. Obviously, this isn't a setup that you want to get in on early, since a stock can continue to fall within the wedge while investors wait for a breakout. That said, when the move happens, traders will want to take heed.
Expect momentum to be an early tip off to the move in price.
We're seeing the same setup in another giant stock: Exxon Mobil (XOM). Even though these two businesses couldn't be more different, a quick glance at the two charts makes it clear that they've been trading almost identically for the last couple of quarters. That's not hugely surprising; they're both S&P 500 components, and their correlations are extremely high as a result of that. For traders, that just means that there's another falling wedge trade in play night now.
In Exxon, the setup works the same way. The stock has been moving in a downtrend, but the trendlines defining the moves are convering -- in other words, the stock is falling, but it's falling at a diminishing rate. The move above the upper trendline marks a buy signal in this stock too.
Momentum tells a slightly fuller picture in this stock. As with WMT, 14-day RSI has been bumping up against a downtrend of its own that's likely to break out ahead of the price move. But the fact that longer-term momentum is actually in an uptrend (the dashed grey line) is bullish. No matter what happens, it's critical to wait for the price breakout to happen before putting real money on the line -- after all, you can't make gains off of RSI, just price.
The last few months have been a lot more positive for shares of Toronto-based AuRico Gold (AUQ): shares of the mid-cap gold miner are up more than 25% in the last quarter. That, incidentally, is a whole lot better than spot gold has fared over the same period of time. But AUQ looks poised to head even higher in the near-term thanks to the technical setup in shares right now.
AUQ is forming an ascending triangle pattern, a setup that's formed by horizontal resistance above shares and uptrend support below them. Essentially, as AUQ bounces in between those two price levels, it's getting squeezed closer and closer to a breakout above that $9.50 resistance level. When that happens, we've got a buy signal for this stock.
Whenever you're looking at a technical pattern, it's important to think in terms of buyers and sellers. After all, triangles, wedges, and the like are a good way of describing what's happening on a chart, but they're not the reason why it's tradable. Instead, it all comes down to the supply and demand caused by those buyers and sellers.
The horizontal resistance level in AUQ is a place where sellers have previously been more eager to sell and take gains than buyers have been to keep buying. But uptrending support tells us that buyers do have some control over shares at lower levels. The breakout means that buyers were able to absorb all of the excess supply of shares that was sitting above $9.50. Without that price barrier, this stock should have a lot more room to run.
Automotive component maker BorgWarner (BWA) could be in for some good fortune of its own thanks to a reversal pattern that was shaping up in shares for the better part of 2012. Now, with this stock exceptionally close to a breakout level, investors had better take a closer look at this setup in January.
BorgWarner is currently forming a double bottom, a reversal pattern that's formed by two swing lows that bottom out at approximately the same price level. Those two bottoms are separated by a peak, a level that marks the trigger point for this trade. For BWA, that breakout level is $77.50 -- a move above that price sends a buy signal for this stock.
When the breakout does happen, I'd recommend keeping a protective stop nearby.
Last up is environmental services firm Clean Harbors (CLH).
Clean Harbors spent the last year in a downtrend, dropping in value by more than 12.44%. But this stock is another example of a potential reversal in January. Right now, Clean Harbors is forming an inverse head and shoulders pattern, a setup that's formed by two swing lows at approximately the same level (the shoulders) that are separated by a deeper low (the head). The pattern indicates exhaustion among sellers, and after the decline this stock has had in the face of a broad equity rally, it shouldn't come as a shock that sellers are a little bit fatigued by now.
The buy signal comes on a breakout above the stock's neckline, which comes in at $62. Some traders are anxious about trading a popular pattern like the inverse head and shoulders -- but they shouldn't be.
A recent academic study conducted by the 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."
That's a good reason to pay attention to CLH this month.
To see this week's trades in action, check out this week's Must-See Charts portfolio on Stockpickr.
At the time of publication, author had no positions in stocks mentioned.
Jonas Elmerraji, CMT, is a senior market analyst at Agora Financial in Baltimore and a contributor to TheStreet. Before that, he managed a portfolio of stocks for an investment advisory returned 15% in 2008. He has been featured in Forbes , Investor's Business Daily, and on CNBC.com. Jonas holds a degree in financial economics from UMBC and the Chartered Market Technician designation.