Investors can be rewarded handsomely by buying beaten-down sectors at the right time. In 2008, financial stocks were at the center of the storm that threatened the global financial system. An ETF that tracks an index of banking stocks, SPDR S&P Bank ETF (NYSE: KBE) fell more than 85% during two years, and some of the biggest banks in the world fell even more. Citigroup (NYSE: C), for example, fell more than 98%. Eventually, the declines stopped and traders who bought near the lows were well rewarded. KBE is now more than 160% above its lows and Citigroup is almost 300% above its lows.
Traders should always be on the lookout for the next sector turnaround, and I think I've spotted it. Turnarounds are different than bottom-fishing, a strategy used by some traders who try to buy while prices are falling in the hopes of catching the bottom. I wait for prices to turn up and form a recognizable bottoming pattern on the chart.
We will never buy an absolute low with this strategy, but waiting for prices to stop falling minimizes the risk on a trade. Bottom-fishers often find that the stocks they buy continue falling. Trading chart patterns that show a potential trend reversal offers a trade with a higher probability of success and risk can be minimized with a stop-loss that is based on the market action rather than guesswork.
Even though the chart says to "buy," buying into a turnaround should be done with caution. I'm convinced that Guggenheim Solar (NYSE: TAN) is ready to move higher in the short term, but this is definitely a sector that will have to climb a wall of worry.
A JPMorgan analyst recently said, "We see the issues currently plaguing the Solar (photo voltaic) industry -- significant overcapacity and declining demand in Europe, which historically has been the largest market -- continuing in 2013."
Other analysts are bullish and looking for the industry to enjoy its best quarter ever in the fourth-quarter of 2012, a factor that should boost earnings reports that will start coming out next month.
While the analysts are uncertain, the chart of Guggenheim is bullish.
The stock has actually been trending down since it started trading in 2008. The chart above shows that Guggenheim took a break from this trend in January for the past two years. These are actually the kind of stocks that seem to be perfect candidates for trading the January effect.
Small-cap stocks show a tendency to outperform large caps in January. Many traders believe this is because long-term investors sell losers for tax purposes late in the year and buy them back 30 days later, again for tax purposes. By selling, they can recognize losses on their tax returns.
The steady downward trend in solar stocks makes them ideal candidates for tax selling since almost everyone who bought this ETF will be showing a loss now. Tax law allows traders to recognize the losses only if they wait at least 30 days before buying the investment back. Solar stocks are in an industry that has significant long-term potential and some investors will want exposure to the industry, making them buys in January.
The weekly chart shows a small bottoming pattern has formed since the beginning of November that projects a price target of $17.50. Resistance near $18.50, about 14% above the recent price level, can also be seen on the chart. Support should be found at $15, the top of the pattern formed in November, and that is the level traders buying the stock should consider as the stop-loss, risking about 8%, or $1.50.
As an alternative to buying Guggenheim, traders should consider January call options with an exercise price of $17. These options are trading at about 20 cents and would be worth at least $1.50 if Guggenheim reaches $18.50. Recognizing the high risk in this ETF, traders buying calls should close the trade if the value of the option doubles, which, at current option prices, should happen if Guggenheim reaches a price of about $17.40.
Action to Take --> Buy Guggenheim Jan 17 Calls at 50 cents or less. Do not use a stop-loss. Set price target at $1 for a potential 100% gain in five weeks.
This article originally appeared on TradingAuthority.com:
A Turnaround in This Beaten-Down Sector Could Double Your Money in 5 Weeks