Trading The Trend In An Overbought Market

01/20/11 03:30:53 PM

by Billy Williams

It can be nerve-wracking when looking to enter a long position in an overbought market, but there are key factors to consider to do it successfully.

Security: GOOG, CLB, EW
Position: Buy

The market marches onward, going higher and higher with no indication that it intends to pull back or slow its advance. Seasonal patterns suggest that the market is due for a pullback, but there is always the possibility that the major indexes will shrug off historical patterns and continue higher.

The important thing to keep in mind is to trade the price action as it trades in the present while being mindful of historical patterns that have statistical relevance that would affect the current trend. In short, trade the trend as it exists, but remain aware of anything that could change and adjust accordingly.

Being a successful trader is largely trading what you have in front of you without overthinking the trade but still preparing for any contingency, which is why stop-loss orders and sound risk control are vital.

Currently, the overall market is still trending higher, and there are key stocks that are helping lead the way to new highs.

FIGURE 1: GOOGLE. GOOG formed an inverse head & shoulders pattern in mid-2010 before clawing its way higher. Now, a buy signal is triggered as it trades up through a key buy pivot area.

Graphic provided by: www.freestockcharts.com.

Google (GOOG) has been somewhat of a basket case over the last six to 12 months but formed an inverse head & shoulders pattern, the neckline of which was broken in September 2010. This signaled a bottom taking place from which Google began to trade higher before an explosive price lap occurred, followed by a price consolidation.

During this period of price consolidation, Google's trading allowed the market to absorb the new trading at a higher price, then shored up support during a brief price decline. Now, Google has traded up through a key buy pivot area set on November 9, 2010, confirming a buy position into this stock and giving Google an opportunity to take the market higher along with its stock's price action as well as for traders the potential for a runaway move. See Figure 1.

FIGURE 2: CLB. CLB is a strong stock in a company that competes on the world stage in the oil markets. A long entry awaits right at the buy pivot area of $92 as the stock trades higher.

Graphic provided by: www.freestockcharts.com.

Core Laboratories (CLB) is another example of a solid company with impressive fundamentals that had been in a solid uptrend until global markets melted down after the housing crisis in the US back in 2008. CLB is a world leader in the discovery, development, and production of oil reserves throughout the world and ongoing projects in dozens of countries in every major continent on the planet.

CLB set an all-time high of slightly over $92 in late December 2010 before pulling back into a brief period of price consolidation but is now trading upward and looks to be setting up for another long entry. See Figure 2.

FIGURE 3: EW. EW has been on a strong bull run ever since it began trading shares and recently formed a bullish flag pattern and signaled a long position. If you missed it, a second entry awaits at the former high, which acts as a buy pivot at slightly over $85.

Graphic provided by: www.freestockcharts.com.

Edward Life Sciences (EW) has been in a solid uptrend for almost the entire time it has been open to the public for trading. It has recently formed a bullish flag pattern and signaled a buy entry from the trendline break. However, if it trades up to and through the all-time high, then that is another valid buy point. See Figure 3.

Since the market is already bought, there are two ways to go about trading stocks like these: first, trade the stock while being mindful of the potential of a sudden if not violent selloff, and second, use stock options to help limit risks while still enjoying the benefits of high leverage.

Even an overbought market can trade higher and become more overbought, so adjust your strategy to take advantage of the probability that the trend will continue while coming up with a contingency plan for the unexpected.

Option trading, particularly the use of spreads, can help you minimize your risk while still gaining higher than average returns, but unless you are skilled in this area of trading, then it might be better to trade directionally with straight call options while still limiting a portion of your risk to a set percentage of the option premium itself.

Billy Williams

Billy Williams has been trading the markets for 27 years, specializing in momentum trading with stocks and options.

Company:	StockOptionSystem.com

E-mail address:	stockoptionsystem.com@gmail.com
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Date:�01/25/11Rank:�3Comment:�

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Trading The Trend In An Overbought Market

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