Two Ways You Can Play an Early Trend

You don’t have to wait for a stock to break out to new highs before pulling the trigger…

Sure, you’ll come across some high-probability trades that just happen to coincide with a 52-week breakout. That’s fine. In fact, it can be ideal. But as a trader, you have to face this important fact: chasing new highs is not an effective strategy. You shouldn’t throw money at every stock on the market just because it’s having a good day. It’s reckless at best. At worst, this kind of behavior can drain your brokerage account in the blink of an eye.

Today, I want to show you a couple of methods you can use to spot a stock well before it speeds to new highs. I’ll also show you real-world examples detailing exactly how these set-ups can make you money. If you follow my simple instructions, you’ll have the tools you need to catch a newer trend while it’s developing.

A Trend Playbook reader G.K. sent me a note that got me thinking about today’s column. He commented on my stock screen tutorial and how he might customize my metrics:

[I] Need to tweak the parameters a little bit to get closer to the start of the trendline, but that shouldn’t be too difficult. Nothing wrong with your approach, I just like to get in a little sooner (a bit risky I know).

–G.K.

I have a couple of things I want to point out from this note. First, G.K. appears to have some trading experience. He knows what he wants to look for, so he’s customizing the screen to get his ideal results. My goal is for you to be able to adjust your screening metrics soon enough, too.

He also mentions how he prefers to “get in a little sooner” on some of his trades, and how this tactic can increase risk. That can be true. However, you can find stocks that are beginning to show signs of turning around. You can also catch the trend early on–without taking on unnecessary risk.

Here are two setups you should look for to snag recovering stocks during the early stages of a new trend:

1. Double Bottom

The name of this pattern is self-explanatory. With a double bottom, you should be looking for stocks that have found support near the same level and are pushing higher.

Here’s what it looks like:

Goldcorp Inc. (NYSE:GG) endured a steep downtrend for much of 2012. But the stock has found support at $32. Resistance is near $42. You have your buy signal if and when the stock breaks the solid blue line.

You can search for double bottom patterns using the “Signal” function on Finviz.com. This pattern recognition feature isn’t perfect, but it will give you a few decent examples to help you get started on your search:

2. Rounding Bottom

A rounding bottom occurs when a stock slowly begins to bottom out of a prolonged downtrend. Sellers become exhausted, and buyers begin to step in and test the waters, slowly bringing the stock back to life.

Here’s an example:

Again, you’re looking at a stock that’s coming out of a powerful downtrend. Note the saucer-like shape of its recovery. Your entry signals are previous resistance levels. A higher-risk entry (possibly for a day trade or short swing trade) occurred this morning as the stock broke above its August highs. A safer entry point would be at $2.20 – a more significant resistance level.

One final note:

This chart I used of Sonus Networks Inc. (NASDAQ:SONS) is not an ideal example of a rounding bottom. I usually prefer to see a much wider “saucer” consolidation period before considering a rounding bottom trade. However, I chose SONS because it works well zoomed-in with nicely defined resistance levels. As always, you should be selecting set-ups and trades that fit your trading style and risk appetite.

Best,

Greg Guenthner

Two Ways You Can Play an Early Trend was originally featured in the Penny Sleuth.

This story was originally featured on Penny Sleuth.