This Trade Wins 78% of the Time in an Oversold Market

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Stocks were mostly lower last week but rose Friday, Nov. 16, when U.S. political leaders expressed optimism that a deal to avert the fiscal cliff is possible.

Trend may be determined by answer to 'What If…?'

What if the tax increases and spending cuts associated with the fiscal cliff are allowed to take place? Stocks fell last week as traders pondered this possibility. What if Congress and the president can reach a deal and avoid the cliff? We saw stock prices move higher when this scenario became a possibility in the minds of traders. The long-term trend in stocks may be revealed when one of these two questions is answered definitively.

Despite a 0.49% gain on Nov. 16, SPDR S&P 500 ( SPY ) was down 1.3% for the week. PowerShares QQQ ( QQQ ) , an exchange-traded fund (ETF ) that tracks the 100 largest Nasdaq stocks, fell 1.78% last week and is now down more than 5% in the past four weeks.

ProShares UltraShort QQQ ( QID ) , an ETF that goes up when the Nasdaq 100 goes down, was up 3.5% last week and is up 13.52% in the past month. The chart shows that QID has now reached itsprice target . The ETF has been overbought for most of the past month and a smallbearish divergence developed in thestochastics indicator last week. A short break in the strong uptrend for this inverse fund is now likely.

With stocks generally higher the week of Thanksgiving and trading shortened for the holiday, now seems like a good time to book aprofit in QID. We may buy this ETF again very soon, but there is a good chance stocks will see a short-lived recovery before a downtrend resumes.

Based on the high probability of a short-term rally, aggressive traders should buy ProShares Ultra S&P500 ( SSO ) . This is very likely to be a short-term trade lasting one to three weeks. In the past, when the S&P 500 has become as oversold as it is now, buying SSO has been profitable 78% of the time (7 out of 9 times). On average, SSO has gone up an average of 5% three weeks after this buy signal.

Recommended Trade Setup:

-- Sell QID at themarket price (at Friday's close, this trade showed a 17.8% profit since it was opened on Oct. 8)

-- Buy SSO at the market price

-- Set stop-loss at $53

-- Set price target at $57 for a potential 4% gain in 1-3 weeks

Gold sold off with stocks again

The strong correlation between gold and stocks was apparent again last week when SPDR Gold Trust ( GLD ) fell 1.16% for the week. Global X Silver Miners (SIL) also broke down and fell below the stop-loss set for that trade, resulting in an 8% loss. For now, it is best to wait for a trend to develop in gold.

TheBollinger Bands have been narrowing, a sign that increased volatility is likely soon. The stochastics indicator is bearish, but the downside price target is $163.40 based on the lower Band, less than 2% below the current price. A decisive break below that level would lead to a short trade opportunity. A reversal from that level could be a buy signal.

Gold might stay in a narrow trading range for some time. Long-term concerns aboutinflation are likely to support gold near current levels, but fundamentals do not support significant short-term gains in the metalsmarket .

Inflation is low in developed economies around the world: 2.2% in the United States; 2.5% in the euro zone; and 0.3% in Japan. Until the pace of economic activity picks up, inflation pressures are unlikely to build. Global tensions, especially the potential for war in the Middle East, could become a factor in the gold market, but for now, traders should wait for the news to change and enter the market when a trend develops.

Action to Take -->  Withearnings season set to wrap up, negotiations in Washington as the fiscal cliff nears are likely to dominate the news. An agreement or a breakdown in talks can come at anytime and traders need to be ready to react. Based on last week's market reactions, expect a short-term price rise if any kind of a deal is reached and a sell-off if negotiations collapse. The short-term reactions make trading difficult in the near term, but the long-term trend in stocks is down. 

This article originally appeared on TradingAuthority.com:

Market Outlook: This Trade Wins 78% of the Time in an Oversold Market



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

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This article appears in: Investing , Investing Ideas , Stocks

Referenced Stocks: GLD , QID , QQQ , SPY , SSO

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