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The Market Begins To Break Away

09/07/12 08:48:18 AM
by Billy Williams

Good news from the European Union and the US sent the stock market soaring, with stock leaders offering solid trades for big profits.

Security:   SPX, AMZN, PII
Position:   Buy

No sooner than I wrote that the market was experiencing an extreme period of contraction coupled with a highly bullish chart pattern on the long-term time frame, it broke out with a vengeance to the upside. In its former state, price was stuck in a tight trading range as traders and investors sat on the sidelines and the bulls and bears were unable to take control of the trend until some external catalyst changed the underlying dynamics of the market's sentiment.

But now, Europe announced a new initiative that gives the European central bank an unlimited checkbook to begin a bond-buying program for countries weighed down by destructive debt with the aim of releasing some of that pressure and instilling faith back in consumers.

Whether the program is a success or not, Wall Street reacted positively, as the new initiative shows the European Union taking some type of action to control the spiraling debt problem that has plagued many of its member nations as well as show attempts to keep inflation under control. This translated into the Standard & Poor's 500 gaining more than 29 points (Figure 1), the NASDAQ gaining 67 points, and the Dow Jones Industrial Average (DJIA) gaining just over 233 points, all moving on rising volume.

FIGURE 1: SPX. The market exploded on the EU's new bond-buying initiative as well on positive news from key stocks that instilled confidence in investors on Wall Street today.
Graphic provided by:
In the US, several well-known stocks exploded on a combination of the EU's bond-buying initiative and positive developments in the companies themselves, such as Amazon, which traded higher on above-average volume. Amazon launched its new Kindle line, its signature tablet that allows readers to read digital books, watch videos, play computer games, and more, including shopping its online store. Dubbed the "Walmart of the online world," Amazon has a massive competitive advantage over other ecommerce operations as well a tremendous brand along with almost 330 million registered users who have credit cards on file for impulse buying.

FIGURE 2: PII. PII traded higher through a buy point but did so on lower volume and a distorted cup & handle pattern, which usually indicates that this is a breakout trader that you would pass on in favor of a more reliable setup.
Graphic provided by:
Amazon has also spread its vast distribution network into publishing where its new publishing division courts independent authors, novice writers, and short story authors as well as name-brand authors away from the Big Three publishing houses in New York. If Amazon knows how to do anything, it knows how to sell books and has a built-in consumer base to offer authors of all levels a platform to reach new readers and gain fans. While the new Kindle tablets are reported to sell at a loss for Amazon on the front end, the back end sales of books, computer games, DVDs, and more make up for the loss at a significant profit over the long run.

While some stocks made significant progress, it is important to take into account not just the price action but trade volume and the technical criteria as well. Polaris (PII) traded past a $78.04 buy point off a cup & handle pattern, but a closer look at the pattern reveals the breakout occurred on lower volume, -13% below PII's average (see Figure 2). In addition, the handle portion of the pattern was flawed; some cup & handle patterns form with two handles, as is the case with PII, and such distortions in the setup require you to rethink your entry, even abandoning the trade altogether for a higher-probability setup instead.

Look for the market to trade upward while being prepared for any stall in price action as the US election approaches. If the market looks to climb higher, buy on the breakout or on any pullback. If price stalls and rolls over, exit and wait for further confirmation.

Billy Williams

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

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