Synchronized markets become difficult trading environments. If you correctly gauge the direction, gains will come your way. However, if you are wrong, losses quickly mount. I much prefer situations where certain stocks are weak and others strong because they allow us to hedge our positions and profit from the basis between items as opposed to the direction of prices.
Unfortunately, the current environment is marred by mass weakness and impending doom. I study hundreds of charts each day and they are all painting a similar picture-stock prices have moved off their recent highs and now rest at levels where any future weakness will propel prices lower. Consider two of our recent short sales recommended in my weekly newsletter EPIC Insights, Visa (V) and Potash (POT). We shorted V when the long-standing uptrend (black line) was broken on increasing volume (blue arrow). Since then, a persistent downtrend (red line) has brought the stock to support (blue line). Were this support to fail, prices would quickly drop to the low $50s and raise the possibility that the January low could be retested.
POT tells a similar story. The shares have fallen toward the 50% retracement on increasing volume and now the stock rests below its 200-day moving average (MA) for the first time in two months. If the 50% retracement ($83.89) fails to offer support, we can expect POT to quickly fall toward $75.
Having correctly positioned for these declines, we now face a difficult decision. All of our positions profit from a fall through key support, but will result in losses if prices rally. Therefore, the best way to minimize our risk is to find a stock offering similar technical patterns and position for a rise.
Cliffs Natural Resources (CLF) is a mining company that we owned months ago when it was selling at a large discount to fair value. Having profited from a fundamental trade, we now study the technical view. Since January, CLF has topped out between $31 and $32 on four different occasions (blue circles). Each time, the stock quickly retreated and gravitated toward support at $20 (green line). On two occasions, support held (blue arrows) and the stock quickly moved toward $30 in a matter of weeks. However, when support failed (red arrow), the price collapsed.
With the shares having closed just above support, we have a chance to make a trade with limited risk, yet great returns. Buying the shares at the current price offers a potential gain of 44% if support holds and the shares go toward $30. By contrast, if the price falls through $20 the potential loss is only 4%. With a payout so heavily skewed in our favor, CLF offers a reasonable way to hedge our current short positions and profit from any rally in the stock. I recommend a long position in CLF as this week's technical trade. Use a close below $20 as a stop-loss.