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5 Technical Setups for a Market Selloff - 7871 views
BALTIMORE (Stockpickr) -- Stocks have been selling off for the last week, dropping close to 4% since July 8. While today’s early market action stands to give traders a reprieve from that selling, it’s likely to be a short one. While stocks continue to sell off, let’s take a look at the other side of the market, choosing instead to look at promising technical setups.
It’s important to note that while the decline in the market has been constant for the last week, it’s more thanks to a lack of buyers than an abundance of bears. That’s a crucial distinction because it indicates that the potential for a snapback rally (like the one that kicked off July) exists -- particularly as strong earnings continue to trickle in.
From a technical analysis standpoint, there’s reason to be bullish on specific sectors and stocks right now.
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Remember, technical analysis is a way for investors to quantify qualitative factors, such as investor psychology, based on a stock's price action and trends. Once the domain of cloistered trading teams on Wall Street, technicals can help top traders make consistently profitable trades and can aid fundamental investors in better planning their stock execution.
Here’s a look at this week’s setups.
First up this week is aluminum producer Alcoa (AA), coincidentally the first company that reports earnings each quarter. Even though Alcoa reported substantially larger second-quarter profits last Monday, shares have fallen more than 7% in the days since. But investors shouldn’t jump ship just yet.
That’s thanks to a falling wedge in shares of this metal stock. While a falling wedge looks bearish at first glance, the key to this setup is the fact that it has converging trend lines -- convergence indicates that selling pressures are waning. Statistically, the wedge is a highly predictive pattern, correctly determining directional bias in shares nearly 90% of the time in studies.
For the Alcoa trade to take effect, we’ll need to see shares definitively break above that upper blue trend line. It’s crucial not to get in early on this trade. Because the pattern is downtrending, shares could conceivably fall much further before sending the “buy” signal. Once the breakout happens, this becomes a high-probability trade.
Brookfield Asset Management
Property and infrastructure asset manager Brookfield Asset Management (BAM) is another name that’s showing a bullish setup on a longer-term time horizon right now. Shares of Brookfield have been forming a bullish ascending triangle setup since the start of 2011; now, traders should be looking out for this stock’s “buy” signal.
Simply put, an ascending triangle is a setup that’s spotted with a horizontal resistance level on the upside with uptrending support below. As those two technically relevant levels get closer together, buyers are absorbing supply of shares at resistance -- once that oversupply gets absorbed, the potential for a breakout occurs.
In the case of Brookfield, a breakout above $34 is the buying signal that you should be watching for. When it happens, consider a protective stop just below the 200-day moving average.
Brookfield Asset Management shows up in the portfolio of Bruce Berkowitz's Fairholme Capital Management and is one of the top holdings of Murray Stahl's Horizon Asset Management.
Despite the recent selling in stocks, 2011 has been a strong year for shares of French pharmaceutical firm Sanofi (SNY). Shares of the $100 billion firm have climbed more than 19% since the first trading day of January -- and it looks like they could have further to run.
That’s because shares of Sanofi are forming an inverse head-and-shoulder setup, a well-known pattern that indicates exhaustion among sellers. On a head-and-shoulder (either inverse or regular), the breakout signal comes when shares punch through the pattern’s neckline. At that point, the balance between supply and demand for shares of Sanofi favors buyers.
Don’t put too much emphasis on the numerous gaps in Sanofi’s price action. These gaps, known as suspension gaps, occur because this stock trades in Europe outside of normal trading hours here in the U.S. They’re not relevant to the setup -- only the neckline is.
Hecla Mining Company
Small-cap silver miner Hecla Mining Company (HL) is another strong example of an inverse head-and-shoulders pattern that’s nearing a breakout right now.
With strength in silver prices this month and a neckline at $8.75, traders have a pretty well-defined buy trigger for this stock. Hecla is a popular trading vehicle for investors who are looking to get exposure to silver prices through junior miners -- as a result, volume should be more than adequate to generate a solid breakout trade. As was the case with Sanofi, it’s necessary to wait for a push above the neckline before taking a position in this stock.
Of course, this isn’t the first silver trade we’ve taken on in July.
Hecla shows up on a recent list of 8 Mining Stocks to Watch.
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iShares Silver Trust
The resulting trade would have generated gains of more than 11% as the S&P 500 lost value.
If you’re still in this ETF, it’s not necessarily time to unload units just yet. Metals are performing well as an alternative to equities in this market. While some semblance of a correction is likely today as stocks bounce a bit, I’d recommend holding onto SLV until we see a move below $38 support. For now, consider any position in SLV to be insurance against more broad market moves lower.
To see these plays in action, check out the Technical Setups for the Week portfolio on Stockpickr.
-- Written by Jonas Elmerraji in Baltimore.
At the time of publication, author had no positions in stocks mentioned.
Jonas Elmerraji, based out of Baltimore, is the editor and portfolio manager of the Rhino Stock Report, a free investment advisory that returned 15% in 2008. He is a contributor to numerous financial outlets, including Forbes and Investopedia, and has been featured in Investor's Business Daily, in Consumer's Digest and on MSNBC.com.