To Cope With Volatility, Hold Stocks Longer

With volatility at extreme levels, traders are looking for new ways to play the financial markets. Many of us have moved back into the daytrading arena, where there's shelter from the huge gaps that have become so common in this bear market. But even in this fast-fingered venue, the wide ranges can hurt, rather than help, our bottom lines.

The other side of the time spectrum is attracting less attention these days, but it might offer a more effective solution in early 2009. Lengthening our holding periods and trading off the weekly charts reduces the noise levels considerably and lets the underlying trends develop, with less risk of stop-running or news shocks.

However, trading with larger-scale patterns requires a good measure of discipline, because specific rules must be followed in order to take advantage of the profit opportunities.

• Position sizing: Lower your position size, as compared with typical exposure in a daily or intraday trade. Then allow the stock to move over much greater distances, higher and lower, without touching it. Once positioned, place a loose stop loss well outside the trading ranges that have set up over the course of weeks or months.
• Entry at the edges: Trade at the edges of broad support and resistance levels. This requires sitting back and stalking interesting patterns for days or weeks, until they move into price levels that are favorable for your intended strategy. Positions can then be taken with scaling methods and a sharp focus on average price.
• Selectivity: Opportunity cost is a major issue in trading weekly patterns, because you're tying up working capital for a long time. In this regard, you can utilize your cash productively by avoiding stocks that are caught in the middle of broad ranges or grinding through chaotic patterns that show no developing trends.
• A giant step back: High volatility isn't likely to vanish anytime soon. In other words, your position is going to move around, sometimes violently, before hitting your stop loss or entering a trend that will generate a profit. It's your job during this period to back off and not get sucked in by short-term price fluctuations.

Now that I've whetted your appetite for this type of market play, let's look at three long-term patterns that could set up profitable positions in the weeks and months ahead.

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Gilead Sciences (GILD) eSignal

Gilead Sciences(GILD Quote) topped out in the upper $50s in June, after a multiyear uptrend. It tested that level in August and rolled over, breaking a two-year trendline. The decline found support in the mid-$30s, with price pushing back to broken support in October. It's been pressing against that level for the last two months but has failed to remount it.

The price zone between $47 and $50 looks like a good place to build short sales in anticipation of a renewed downtrend that tests the sequence of higher lows posted in October and November. A break of that rising red trendline will set up a test at the bear market low and the possibility of a continued decline into the $20s.

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Entergy (ETR) eSignal

Entergy(ETR Quote) sold off from $123 to $61 before bottoming out in October. The bounce stalled immediately at $87, with price dropping into a sideways pattern that has persisted for the last two months, A November test at the recovery high was turned away, and the stock is now trading about 7 points off that developing resistance level.

Trading ranges have been compressing since October, indicating that price is setting up for a larger-scale trend. This is interesting from the long side, because a breakout over $87 could trigger a fast rally up to stronger resistance near $100. The weekly pattern might support building new positions in the upper $70s, ahead of that event.

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Southwestern Energy (SWN) eSignal

Southwestern Energy(SWN Quote) rallied into the upper $20s in 2005 and then moved sideways into late 2007, when it broke out in a strong uptrend that lifted price to the low $50s The stock topped out at that level last summer and sold off, testing breakout support in October and bouncing strongly.

Subsequent action has carved the outline of a volatile bull flag that should give way to higher prices in the first quarter of 2009. The stock is currently trading near the midpoint of this pattern, so it could take time for the new uptrend to evolve. In the meantime, scaling in with an average price in the mid-$20s could offer a low-risk entry.

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Alan Farley provides daily stock picks and commentary with his "Daily Swing Trade" newsletter.

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Know What You Own: Gilead's competitors include Bristol-Myers Squibb(BMY Quote), GlaxoSmithKline(GSK Quote), Pfizer(PFE Quote) and Sanofi-Aventis(SNY Quote).