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The 2 rules of catching a falling knife

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From Jeff Clark, Editor, Jeff Clark’s Market Minute:

Most traders are familiar with the clichéd Wall Street warning of “don’t catch a falling knife.”

You see, buying into a stock that is falling sharply is generally a bad idea. While picking the bottom of a stock can lead to massive gains… if you buy at the wrong time, it can also lead to big losses. And, frankly, most of the time… that’s what happens.

But there are times when the knife is so close to the ground – where the risk of further loss is minimal, and where the potential gains are so enormous – that it makes sense to reach out and grab it.

Today, I’m going to show you how to find these setups…

Let’s start by looking at an example. Take a look at this chart of Lululemon Athletica (LULU), the sports apparel manufacturer known best for its line of yoga clothes…

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Back in December 2013, LULU shares dropped nearly 20% overnight (point 1 on the chart) in reaction to some bad news from the company. Now, it doesn’t matter what the actual news was. The important thing to recognize here is that this was NOT a good time to buy shares of LULU. Bad news is usually NOT a one-time event. There’s almost always a second shoe to drop.

So if you want to profit from “falling knives,” the first rule to follow is to never buy a stock on the first decline from bad news. There’s usually more trouble to come.

Sure enough, after a brief period of consolidation from mid-December 2013 to mid-January 2014, LULU once again tumbled 20% (point 2 on the chart) in reaction to bad news.

This brings us to our second rule… After the second shoe has dropped, traders can start looking to buy – if the technical condition supports a bottom.

I like to look at the moving average convergence divergence (MACD) momentum indicator to get an idea of where a stock is likely headed next.

The MACD indicator helps to gauge the overall strength of a trend. For example, if a stock is dropping to new lows and the MACD indicator is hitting new lows as well, then the downtrend is strong and likely to continue.

On the other hand, if the stock is dropping to new lows but the MACD indicator is rising, this “positive divergence” is likely an early sign that the trend is ready to reverse.

In the above chart, when LULU dropped to a new low in early February 2014, the MACD indicator also dropped to a new low – confirming the downtrend in the stock.

No matter how attractive the stock might look at this point, traders should avoid the temptation to buy it if the technical condition doesn’t support a bottom. There’s still more room to fall and at least one more shoe to drop.

That’s what happened in June 2014. Once again, LULU announced bad news and the stock fell 15% in one day (point 3).

But notice the different action in the MACD indicator at this point. As LULU was dropping to a new low, the MACD was trending higher. This is the sort of positive divergence that reduces the risk of catching a falling knife.

At this point, we had a stock that had fallen hard three times on bad news. It was trading for half the price it traded at six months earlier. And a key technical indicator was signaling that the trend was ready to reverse. This was a low-risk area for traders to buy.

And just look at what happened next…

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As you can see, LULU’s June 2014 low marked the bottom for the stock. But LULU didn’t mount a sustainable rally right away. Instead, the stock chopped around for a few months in a relatively tight trading range. Then it exploded higher. Anybody who caught the falling knife in June 2014 was sitting on around a 75% gain by the following March – just 10 months.

To sum up, if you want to profit from a falling stock – there are two important things to remember:

  1. Never buy a stock on the first decline from bad news.
  2. Only buy a stock when the technical condition of the stock supports a bottom.

If you follow these two rules, you can set yourself up to make big profits with low risk from falling knives.

Best regards and good trading,

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Jeff

Crux note: No matter which direction the markets go, Jeff Clark’s Market Minute subscribers are always up to date on the trends taking shape – and the best ways to profit on them – hours before the opening bell rings.

Sign up for the Market Minute for free right here… and get your next issue at 7:30 a.m. sharp tomorrow morning.


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Gilead and Celgene’s stocks may have more room to run

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CNBC’s Jim Cramer was somewhat surprised to see the biotechnology sector bounce back in 2018 after months of weakness.

“At a time when President Trump keeps slamming the pharmaceutical industry over excessive drug pricing, … you might think that the biotech stocks should be getting slaughtered,” the “Mad Money” host said on Tuesday.

“But you know what? After spending a long time in the doghouse, biotech as a whole is actually having a pretty darned good year, with the Nasdaq Biotechnology ETF, the IBB, up 17 percent for 2018,” he continued.

To make sense of the biotech stocks’ new leadership role, Cramer brought in technician Bob Lang, the founder of ExplosiveOptions.net and part of TheStreet.com’s Trifecta Stocks newsletter team.

Lang, who uses technical tools to track the action in particular stocks, decided to look at the group’s most recent leaders and laggards, beginning with the daily chart of Gilead Sciences.

Since Gilead went out of style on Wall Street in 2015 for curing Hepatitis C — a feat that, somewhat ironically, investors figured would lead to less recurrent business for Gilead — its stock has been pummeled.

But Lang noted that in the last few months, particularly after Gilead’s $11.9 billion acquisition of cancer immunotherapy play Kite Therapeutics, its stock has been bouncing, logging higher highs and higher lows.

Gilead’s stock has managed to break through its 50- and 200-day moving averages as well as its former ceiling of resistance, and key momentum indicators like the Relative Strength Index have surged into positive territory, Lang said.

Better yet, Gilead’s moving average convergence-divergence indicator, which technicians use to predict changes in a stock’s trajectory, recently made a very bullish crossover, telling Lang that the stock could be prime for a rally.

“The stock is overbought right here and the next ceiling comes in at around $82, up $5 bucks from these levels, but given everything else he sees in the chart, Lang believes Gilead can keep climbing,” Cramer said. “In fact, it’s his favorite name in the group and he wouldn’t be surprised if it starts challenging its old highs of around $110 by the end of the year.”

Next, Lang turned to the daily chart of Celgene, a biopharmaceutical giant with a focus on treating cancer and inflammatory disorders.

Shares of Celgene are down 20 percent for 2018 because of concerns about its leading drug, Revlimid, and the rest of its pipeline. But, like Gilead, the stock has been making a comeback in recent weeks.

Lang started by inspecting Celgene’s Chaikin Money Flow, which measures levels of buying and selling pressure in a stock. Not long ago, this indicator turned green, indicating to Lang that institutional buyers were warming up to the stock. He added that the stock has made a “W” formation of late — another bullish signal.

“Right now, the stock’s at $86. [Lang] thinks it could make a move to the 200-day moving average, … currently around $97 bucks, in the coming weeks,” Cramer said. “He may be right given the recent rotation into biotech. Without the rotation, though, I’m less sanguine.”

Lang also threw a third name into the mix — Illumina, a biotech-oriented medical technology company that builds machines for DNA analysis with one of the best-performing big-cap health-care stocks since 2017.

“As far as Lang’s concerned, the chart is a thing of beauty,” Cramer said, noting the stock’s steady climb, “robust” Chaikin Money Flow and “insanely strong” moving average convergence-divergence indicator.

The only issue seemed to be that the stock was overbought, but that didn’t shake Cramer or Lang.

“This thing, though, has been overbought very frequently since 2017. Now, that has never been a reason to sell the stock,” the “Mad Money” host said. “Instead, you’ve done much better if you simply wait for the next pullback — and we get those all the time — and use that weakness to do some buying.”

Lang’s analysis echoed that point, recommending that investors use weakness in Illumina’s stock to buy and strength to sell.

“The biotechs and the biomed techs have finally started showing some signs of life and the charts, as interpreted by Bob Lang, suggest that Gilead, Celgene and Illumina have more room to run,” Cramer said. “My view? Look, if you believe the economy is going to stay strong, then maybe this rally does peter out, but you’ve got my blessing to put on some exposure on any one of these or all of them, as I think Lang is going to be dead right.”



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The greatest obstacle to investing success is… you

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From Richard Smith, Founder, TradeStops:

If you’re like the average investor, you’d say it’s easy to feel overwhelmed at times by confusion in the markets – and sometimes even by fear.

But why should it have to be this way?

Investing is a noble pursuit. Generating wealth for a comfortable retirement means creating the financial freedom to live well in the golden years… while providing support to loved ones… enjoying the finer things in life… and possibly making a real difference in the world.

Those are all good things. The pursuit of good things should not be a stressed-out experience! But for too many investors, that’s exactly what it is. Their market journey is a series of obstacles and worries.

There is bad news and good news here.

First the bad news: Your greatest obstacle to investing success is… you.

And the good news: The solution to overcoming your “greatest obstacle” is within reach.

What does that mean, to say the greatest obstacle to investing success is you?

It means that when it comes to investing successfully, finding great stocks is not the hardest thing. And dealing with volatility is not the hardest thing.

The hardest thing for any investor  and this includes everyone from Warren Buffett on down  is overcoming the natural pitfalls and challenges within their own brains.

Walt Kelly, the artist who drew “Pogo,” had a caption on his most famous cartoon that read: “We have met the enemy, and he is us.”

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That statement could have been tailor-made for investors. Your biggest challenge as an investor will be overcoming your natural behavioral shortfalls and biases  learning to do the right thing and overcoming your built-in bad behaviors in the process.

(And again, this isn’t just “you” specifically. It’s also true for me, and Warren Buffett, and everyone else.)

This really goes back to the essential mission of TradeStops. We want to help as many investors as possible find a path to comfortable retirement. (We’ve helped 25,000 so far, but that number should expand 1,000-fold.)

A key goal of TradeStops is to remove anxiety from the investment process, and in doing so, help investors rediscover the joy of investing as they build long-term wealth.

How do we do this? By combining science, technology, and proven principles of behavior modification.

To get rid of bad investing habits, you can’t conduct brain surgery on yourself (and you wouldn’t want someone else to try).

But you can use software as a tool in the investment decision-making process… which in turn serves as a form of painless behavior modification… which puts you on the path to anxiety-free investment success.

Again, this is what TradeStops is all about: Helping investors overcome their greatest obstacle to investing success… so they can meet their long-term wealth-building goals… and have a positive impact on everyone around them.

Here’s something else funny about the brain: Knowledge makes behavior modification easier.

The better and deeper the brain understands the “why” behind something, the easier it becomes to make a positive behavior change around that thing. And sometimes the “why” is even more important than the rules.

The importance of the “why” was once vividly demonstrated by Ed Seykota, a famous trend follower who made countless millions in the commodity futures markets.

Seykota was one of the earliest adopters of mechanical trend-following techniques. In the 1970s he was a pioneer in the use of exponential moving average crossover systems. (They were so new and exotic at the time, people called them “expedential” moving averages.)

At one point, Seykota decided to teach a classroom course on trend following. For the curious who signed up  remember, trend following was totally new at this point  Seykota spent something like 10 percent of the classroom time explaining the very simple rules of his trend-following system  and the other 90 percent explaining the “why” behind the importance of sticking with the rules!

We’ve realized a similar idea applies to TradeStops software.

No matter how good our software is  and you continue to give us rave reviews, for which we are deeply grateful – it feels like there is always more opportunity to help you, our customers and fellow investors, to get more out of TradeStopsby better understanding the “why” behind certain basic principles.

To that end, we are excited to start something new: An “education series” of editorials, designed to help you become a better investor by sharing the “why” behind some very important concepts.

Our game plan with the education series is to start with the following concepts, exploring each one over a period of weeks or months:

  • Cognitive Biases
  • Probability
  • Investor Psychology

We’re confident the insight you gain from this series can help make you a better investor, even if you aren’t currently using TradeStops. (Though of course, if you haven’t yet experienced the power of TradeStops, we suggest rectifying that immediately!)

Another one of our goals for 2018 is to accelerate the development of TradeSmith University, our ongoing effort to enhance your education as an investor. It goes back to the same set of goals: Giving you more of the “why” behind the principles of investing… so you can make better use of the TradeStops software… in order to reach your wealth-building retirement goals.

It’s an exciting project. We’ve got some great material to draw from, and we’re confident you’ll learn a lot.

If you have any questions, comments, or just something you’ve always wanted to know about cognitive biases, probability, or investor psychology, let us know!

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Richard

Crux note: Richard’s TradeStops philosophy is to cut your losses and let your winners ride… And the results speak for themselves.

You can discover why one satisfied investor called TradeStops his “safety net” right here.


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Two things the World Cup can teach you about investing

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From Jason Bodner, Editor, Palm Beach Trader:

Last week, my phone had a temper tantrum. It just wouldn’t work and was so slow that I couldn’t take it. I took it to the phone store to see my upgrade options.

I brought my three sons. While I waited to get a new phone, they watched the World Cup game in the store.

I wasn’t paying attention, but my seven-year-old Liam proudly proclaimed that Belgium was playing Japan.

This was big deal. (And in a moment, I’ll tell you how it all relates to investing.)

You see, my wife was born and raised in a small city in Belgium. My kids all have dual citizenship. I’m the only one in the family who has just a U.S. passport.

When we left the store, the score was 0-0 at halftime. We were still confident our team would win. There was talk of how Belgium could go all the way. We seemed a sure bet against Japan. (Belgium lost to France in the semifinals on Tuesday.)

About 20 minutes later in the car, I asked Sacha, my middle son, to tell me the score…

Belgium was down by two goals and still hadn’t scored. It was quickly turning into one of the biggest upsets in World Cup history.

Sacha was bummed, but being an optimist said, “You never know… We can come back. It’s not over yet!”

I saw his face was mixed with disappointment and hope. I replied with a weak moment of adult realism: “I don’t know Sach, it seems doubtful. Sorry dude.”

I felt bad the way a dad does when he’s gotta break bleak reality to his kid.

Five minutes later, he said “Oh yeah, Daddy? Look now!” I nearly crashed the car when I saw on his phone that the score was now 2-2. I was screaming with glee with the windows open. It must have looked strange to anyone standing on the street.

When I got home, we ran into the house to watch the final minutes of the game. Belgium scored an injury-time goal to win 3-2.

My sons and I started jumping around. Belgium turned what would have been the biggest upset in the World Cup into the biggest comeback.

Aside from being a fantastic game, there is a point to this story…

You see, I was ready to throw in the towel on Belgium. Psychologically, I had given up.

There was plenty of time for a comeback – improbable as it was. But my mind had written off that possibility and given in to despair.

Sure enough, I was dead wrong. And that’s the point…

Emotion is the true enemy of investors. It can lead to despair and fear. And that can cause you to make drastically wrong decisions.

If Belgium were a stock, emotion would have told me, “I can’t take it anymore!”

I would have sold at the exact bottom.

It took me a long time to learn how to overcome emotion as an investor. Ultimately, the most important thing I had to master was my own mind.

Like most people, I have a knack for doing the wrong thing at the worst moment when I act based on emotion. That’s why I built a stock investing system to take guesswork and emotion out of it.

Your stock positions will move up and down, day-to-day, and week-to-week. The market itself will get bumpy from time to time. We all know this… Yet we still act on our feelings when it happens.

The key to overcoming emotion is to stay rational – especially when things get bumpy.

There are two ways I do this:

  • Stay patient. I need to remind myself that investing in stocks is a long-term game. I need to stick to my system and not sell out of fear.
  • Stay focused. When I feel overwhelmed by emotion, I find it helpful to take a walk or do something to focus my attention on something other than what’s bothering me. For me, listening to music or walking my dogs calms me down and helps me refocus.

Emotions cause us to react. Logic dictates that we stay disciplined. Patience and focus will get us to where we want to be.

Talk soon,

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Jason

Crux note: In case you missed it…

Palm Beach‘s crypto expert Teeka Tiwari is teaming up with political commentator and radio host Glenn Beck to create a one-off special extended broadcast live from his studio in Dallas: The Great Cryptocurrency Conspiracy of 2018.

Tune in July 19 at 8 p.m. Eastern time to discover the secret behind making money with cryptos like bitcoin – something both Wall Street and Washington would like to keep hidden from you…

Click here to register for this free event.


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