Often during a strong market period, traders find themselves with very few opportunities that have a manageable risk associated with them. While many stocks are rising along with the markets, they may be too extended from safe buying points, which unfavorably skews the risk versus reward. If traders chase a stock higher under such conditions, they can easily be shaken out in a normal retracement, even if the stock eventually makes the move they were hoping for.
One way to manage risk in this type of environment is to focus on trading opportunities where a stock is showing a healthy chart and just beginning to emerge from a narrow range rather than trying to catch a stock after a large advance. By focusing on stocks emerging from a narrow range, a trader can employ a tighter stop loss, therefore reducing the risk as a multiple of the possible reward. (For more, see The Stop-Loss Order - Make Sure You Use It.)
One good example of a stock that is just emerging from a narrow range is Enbridge Energy Partners, L.P. (NYSE:EEP). Notice how EEP rallied sharply into its November high near $63 and then settled into a tight consolidation. The trading range for EEP narrowed sharply as it consolidated before EEP finally broke out in late December. However, rather than follow through higher, EEP has since settled into an even tighter range just under $64. Traders should monitor this level, as a break above it could lead to higher prices and provide traders with a narrow range upon which they can base their risk level.
Atlas Pipeline Partners (NYSE:APL) is another example of a stock trading in a tight range and yet showing a healthy longer term chart. APL broke out of a base in October, eventually rising to near $26 per share. It has since settled into a very tight range as it consolidates sideways. Traders should monitor the $26 level for an upside breakout. The level to watch on weakness is near $23.50. A break below this level may imply a trip down toward the prior breakout point and unfilled gap near $20.
EZCORP (NasdaqGS:EZPW) is another stock that has been tightening in its trading range after a sharp rally. EZPW broke out of a base in early November and rallied quite sharply from $21 per share to near $28 per share. It has started to narrow its range as it forms a small ascending triangle pattern. This is typically a continuation pattern and a break above the top of this base could provide a great trading opportunity.
Another stock narrowing in range while forming an ascending triangle is Penn Virginia GP Holdings (NYSE:PVG). One of the characteristics of an ascending triangle is a narrowing of range as traders create equilibrium in the stock's price. PVG is getting close to the apex of the triangle and should break to either side soon. This pattern is typically a continuation pattern so an upside breakout is the more probable scenario. (For more, see Analyzing Chart Patterns: Triangles.)
By focusing on stocks with a strong longer term chart that are still presenting a near-term narrow range, traders can greatly improve their odds of success. This is especially true in a strong market, where traders should focus on limiting risk instead of chasing performance and let the market do the heavy lifting for them. The strong market will provide the rewards as long as traders don't put themselves in poor trading positions. (For more, see The Anatomy Of Trading Breakouts)
At the time of writing, Joey Fundora did not own shares in any of the companies mentioned in this article.