A Perfect 'Needle-In-A-Haystack' Trade

Amber Hestla's picture

Friday, January 25, 2019 - 12:00am

by Amber Hestla

Stock prices ended last week slightly above the important resistance levels I outlined last week. You can see this in the daily S&P 500 chart below. 

spx-chart

After two days of trading this week, prices still had not cleared that level. 

As I noted last week, resistance is a level where a price advance is expected to stall. I identified three specific factors -- the March lows, the 50-day moving average (MA) and the 50% retracement of the October-to-December decline. On Friday, the S&P 500 had closed above each of those levels... which would have been a strong signal that the bear market was ending. 

But when the market opened Tuesday morning, things got off to a rough start. Over the course of the day, the S&P 500 gave back some of the prior week's gains and closed below 50-day MA and 50% retracement level. 

So, does this mean we're in for another round of gains... or does it signal further losses to come? 


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The answer lies in the bottom panel of the chart above -- a simple RSI indicator that I've shown as a histogram. RSI is often used for trading signals, but it's most reliable use can be a market regime indicator. 

Many analysts divide the stock market into two regimes, either bullish or bearish. RSI can quantify that determination. In a bull market, RSI rarely falls below 40, and in a bear market, RSI rarely rises above 60. In the chart, thin horizontal lines mark the 40 and 60 levels. The red zones indicate moves below 40. 

At Wednesday's close, RSI was at 53.2. A move above 60 would confirm the bear market is over. 

The next chart adds my Profit Amplifier Momentum (PAM) indicator to the chart. 

spx-chart2

PAM is now near a three-month high, and that indicates this rally should continue. And that, of course, significantly changes the outlook for the positions we have open in the Profit Amplifier portfolio. 

How I Trade
Every week, I get a lot of questions about how I trade... 

The first thing you should know about my process is that it's automated. I start by screening for companies that offer value. The two criteria I focus on at this stage are (1) growth in cash flow from operations and (2) the price-to-tangible book value, a fundamental measure of value I developed to reduce risk. 

Then, my computer runs those stocks through a technical filter, which helps me determine which trades are ripe for picking. You see, the bane of value investors is timing -- many value stocks remain undervalued for years, and, even if you find a stock with truly great potential, you can't enjoy the profits as long as it's languishing in the bargain bin. My timing tools seek to avoid that problem. 

Because the process is automated, I'm able to find those "needle in a haystack" trades. And this week, my system pinpointed the ripest trade out of a database of 6,129 stocks. 

Some weeks (like this one), I've never even heard of the company flashing the best-looking "buy" or "sell" signal. To me, that means my process is sound. Stocks of little-known companies can deliver large gains when a catalyst brings the company to the attention of traders -- which is the exact scenario that should play out in Radian Group (NYSE: RDN) over the next few weeks. 

A Trade Idea You Won't Find Anywhere Else
Radian Group provides mortgage insurance along with products and services to the real estate and mortgage finance industries. The services segment capitalizes on the expertise needed to underwrite that insurance and provides loan review, due diligence, and surveillance supporting residential mortgage-backed securities (RMBS). 

Radian's mission is "ensuring the American dream." This demonstrates that the company does more than just insure mortgages. It also facilitates the slicing and dicing of mortgages into asset-backed securities (ABS) and improves that process. 

You may remember that 10 years ago, Lehman Brothers' ABS portfolio was at the center of the financial crisis. Well, Radian is working to ensure that type of crisis doesn't happen again. 

Fundamentals are solid, with cash flow from operations doubling in the past 12 months, and free cash flow growing at an average of 60% a year for the past three years. The stock is undervalued at about 1.2 times tangible book value. 

Earnings are expected to be announced around February 1, and that should provide the catalyst needed to bring the stock to Wall Street's attention. 

The chart below confirms my bullish outlook as the stock continues moving higher after recently breaking above its 200-day moving average (MA), the solid blue line in the chart. 

rdn-chart

The most important part of the chart is the "buy" signal on the Profit Amplifier Momentum (PAM) indicator.

Based on the reaction I expect to the upcoming earnings report, the price target for RDN is above $19.40, or about 7% above recent prices near $18.15. Of course, traders could simply buy shares outright, but there is even more upside potential for gains with call options.

For those who are unaware, buying a call option gives the trader the right to buy the stock at the strike price on or before the expiration date. Since investors generally buy calls on stocks they expect to move higher, buying a call option creates the opportunity to share in the upside potential of a stock without having to risk more than a fraction of its market value.

Unfortunately, I can't share the exact details of that trade with you today. This is an open, active trade, and it wouldn't be fair to my premium subscribers to give it away for free. (I should mention, though, that we expect to make as much as 50% on this trade.)

An Invitation To Trade With Me
That said, if you're familiar with how options work, feel free to research this trade on your own. If you like what you're getting, then consider joining us for more trades at this link.

If you're not an experienced trader, then you can still learn more about how my strategy works... all it takes is a few minutes of your time. In Profit Amplifier, we use a simple options strategy to profit from even the smallest moves in either direction -- making far more than investors who simply buy and sell stocks. In fact, we've closed a number of triple-digit gains in the last two months. To learn more, go here.

Amber Hestla does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.