Momentum is clearly bullish … a mindset shift to take part in those gains if you’re wary … understanding Stage Analysis … explosive trading gains from Luke Lango

 

We’re in a rally cycle.

And whether you’re a raging bull who believes today’s fundamental and technical set-up warrant this rally, or you remain a bit wary like me, one thing is true…

There’s a lot of money being made right now.

If you’ve been skeptical, you face two big questions as you wrestle with the possibility of putting more money into this market…

• Are you willing to overlook your red flags and jump into this market while the bullishness is here?
• If so, how do you do it in a way that reduces your risk exposure if your skepticism is eventually proved correct?

Let’s tackle these questions.

The mindset shift that can help skeptics

If you’re approaching the market from a buy-and-hold orientation, your underlying mindset is likely “does this potential investment carry the fingerprints of a stock that will rise in value over time?”

These “fingerprints” might be a low valuation, great sales numbers, an entrance into a new, untapped market – it could be all sorts of things…

There’s nothing wrong with analyzing a stock through this fundamental lens. However, how many times have you identified a compelling reason to buy a stock, yet you lost money? Even if your analysis was spot-on?

That’s one of the challenges with fundamental analysis – even if your analysis is correct, the market has a mind of its own and can refuse to “play nice.”

So, what if you shifted your focus?

Instead, of looking for “fingerprints” suggesting a climbing stock price, what if you simply focused on stocks that were currently offering the result you want…

The rising stock price.

This is what traders do, which has resulted in the trading aphorism “price is truth.”

With bullish price momentum as your focus, answering “why” the stock price is rising becomes far less important – after all, if the stock is doing what you want (generating wealth), the “why?” part is inconsequential.

Today, you can be skeptical of the market’s fundamentals and remain on the sidelines, or you can say “the market is climbing. I might not agree with why it’s climbing, but current conditions are offering me the result I want, so I’m going to take advantage. When the result I want is no longer present, I’ll get out of the market.”

“Jeff, this is stupid. Buying an overvalued stock just because it’s climbing is a surefire way to lose money.”

Well, yes and no.

For the “no” part, let’s turn to legendary investor Bill O’Neill, who founded Investor’s Business Daily. He also created the popular “CAN SLIM” investment method which, in part, requires a stock to have a relative price strength reading of 80 or higher. That usually means a lofty stock price.

Here’s what O’Neil concluded after decades of market experience:

What seems too high and risky to the majority generally goes higher and what seems low and cheap generally goes lower.

To understand why this dynamic often plays out, we need to better understand momentum and the various stages of a stock’s cycle.

The power of “Stage 2” momentum

For help with this explanation, let’s turn to Luke Lango, editor of our trading service, Breakout Trader:

Every stock follows the same repeatable, predictable pattern. That pattern occurs in four stages.

In some of those stages, stocks rise. In others, they fall. The key to making money in any stock, in any market, at any time, is to buy and sell stocks only at the right stages.

Luke uses Apple to walk readers through the stages.

In Stage 1, a stock is consolidating. During these periods, not much happens. A consolidation stage is characterized by sideways movement in the stock price, as seen in Apple’s chart below. The highlighted area is a consolidation stage.

While Stage 1 is basically boring, sideways action, Stage 2 is where the fireworks happen.

Here’s Luke to describe it:

[When buying pressure eventually snowballs], it generates what we call an “upside breakout.” 

This is when a stock reaches a new high price. The stock price literally “breaks out” of its sideways pattern.

You can see how Apple broke out of its consolidation stage in the chart below.

Stage-2 advancements are almost always characterized by a surge in trading volume. This is because more and more investors learn about the company, and they buy shares. 

The increased buying power sends the stock even higher. This makes more people notice the stock and buy, which sends the stock even higher… which makes more people notice… and so on.

The stock enters a self-reinforcing “rally cycle.” 

As we noted at the top of today’s Digest, the S&P is currently in a rally cycle. Meanwhile, a handful of specific sectors are in their own hyper-rally cycles.

Luke writes that it’s not uncommon for top growth stocks to double or triple in value in less than a year during Stage-2 advancements.

Back to Apple, below, you can see it adding 83% in its Stage-2 climb in 2017/2018.

The stages you want to avoid

Eventually, every super-performing stock experiences a correction marked by a period of declining prices.

Perhaps it’s when level heads finally prevail, and investors realize a stock’s fundamentals don’t support the nosebleed levels.

(Here’s where some fundamental investors proclaim, “I told you so!” – even though they might have just missed out on a triple-digit run.)

But before a stock price begins to collapse, it usually goes through Stage 3 – which is when it distributes its gains.

Back to Luke:

This is a period when investors and traders who bought shares before the rally sell their positions and take profits. 

They sell to less-informed investors who are only just now hearing about the stock and are arriving late to the party. 

You can see Apple’s distribution stage below.

Finally, Stage 4 is the correction stage, when a stock price falls over the cliff.

Whereas distribution-stage declines can be in the 10% – 20% range, a true Stage 4 implosion can bring the brutal 50%+ losses that derail investment goals and delay retirement plans.

Clearly, you want to already be out of a trading position when it reaches this stage.

The S&P 500 is in Stage 2 right now

Take a look…

And while Luke is trading this Stage 2 climb in his service Breakout Trader, last week, he introduced a new, higher-octane trading approach. It focuses on one, specific corner of the market that’s in a hyper-bull as we speak.

Here’s Luke:

Over the past year, my team of Caltech quants has developed a first-of-its-kind, AI-driven quant trading system that applies quantitative stage analysis to the most explosive stocks in the market.

We call these “primed stocks.” Most investors don’t know anything about them, but they regularly account for more than 30% of the market’s biggest winners.

And our next-gen model uses quantitative stage analysis to identify only the biggest breakouts in this explosive corner of the market.

“Explosive” is the operable word here.

Below is a snapshot of the portfolio returns of Luke’s new service as I write Monday morning. Keep in mind, the service is barely one week old. In fact, most of the picks are less than one week old.

Now, yes, we’re thrilled with Luke’s results, and we’re very proud to publish them here in the Digest. But I include them to help illustrate the power of a Stage 2 breakout.

And that brings us back to investors who are skeptical today.

You can view this S&P breakout as unjustified fundamentally – and potentially be right – and make zero money…

Or you can look beyond fundamentals – focus on the bullish price action itself as traders do – and ride the gains as long as possible.

But this brings us full circle to the second question from the top of today’s Digest:

How do you trade today’s bullishness in a way that reduces your risk exposure if/when your skepticism is eventually proved correct? What if you buy into this Stage-2 breakout just as it’s entering Stage 3 or Stage 4?

Protecting your Stage 2 winners from Stage 4 losers

When you’re trading based on momentum rather than fundamentals, it’s critical that you incorporate risk management tools.

After all, if Wall Street suddenly realizes a stock’s underwhelming fundamentals don’t justify its surging momentum, a painful price correction could be in the cards. The risk of this is even more pronounced right now during the middle of earnings season.

This is why wise trading rests on two key pillars: smart position sizing and an uncompromising adherence to following stop-losses.

This is a huge topic and there’s a lot we can say on it. Fortunately, our CEO, Brian Hunt, who’s an expert trader in his own right, has already said it all.

Back in March, Brian wrote a “must read” for all traders called The Three Foundations of Wealth. It’s yours, completely free, right here. Please take the time to give a thoughtful, thorough reading.

Back to Luke’s system, he incorporates risk management protocols as well. But because his focus is on outsized returns, he’s willing to accept greater risk. He’s clear that this risk/reward tradeoff isn’t for the average investor:

From Luke:

The ultimate goal?

Find the most explosive stocks in the most explosive corner of the market and buy them for mega short-term profits, over and over again.

Of course, trading these kinds of stocks involves a ton of risk. And we’ve crafted our system to mitigate the risk exposure. Still, nothing is fool-proof. And that’s why this system isn’t for everyone.

If you’d like to learn more about Luke’s system, no strings attached, you can watch a replay of last week’s event in which Luke debuted it right here.

Stepping back, this market is in Stage 2 breakout. Whether or not to trade it is up to you, your investment goals/timeline, and your investment temperament. But with the risk mitigation tools in Brian’s Three Foundations of Wealth, jumping into this market doesn’t have to be quite so scary.

Have a good evening,

Jeff Remsburg