5 Huge Trades for a Volatile 2013

BALTIMORE (Stockpickr) -- Volatility is knocking on Mr. Market's door this Christmas. But that's going to be a very good thing for investors in 2013.

>>5 "Magic Formula" Stocks for 2013

Even though the S&P 500 has already clocked 1.5% gains since Monday's open (and that's after yesterday's 76 basis point haircut), market volatility is extremely low right now. In fact, this entire second half of 2012 has come with exceptionally low volatility for stocks. But that's about to change.

Volatility is cyclical, which means that markets transition from extremely high volatility to extremely low volatility -- and back again. Pull up a chart of the VIX Volatility Index, and you can see that everyone's favorite volatility meter has spiked every 12 to 14 months. The last time we saw a spike was back in mid-2011 -- that means we're overdue for another period of high volatility in the new year.

But that's not a bad thing. In fact, the last spike in the index lines up perfectly with the stock rally that started late last year. When you think volatility, don't think "fear", think magnitude. I've made it no secret that I think we're in store for more upside in stocks from here -- so an uptick in volatility could add some serious buying fuel to that fire.

(It's true that the VIX does have some directional bias, but that's less important for this discussion. For more on the VIX, take a look at How to Trade the VIX.)

With positive volatility looking likely to come into stocks after the quiet Christmas week, investors would be wise to start positioning themselves with attractive trading setups right now. That's why we're taking a technical look at five big names that are tradable this week.

If you're new to technical analysis, here's the executive summary.

Technicals are a study of the market itself. Since the market is ultimately the only mechanism that determines a stock's price, technical analysis is a valuable tool even in the roughest of trading conditions. Technical charts are used every day by proprietary trading floors, Wall Street's biggest financial firms, and individual investors to get an edge on the market. And research shows that skilled technical traders can bank gains as much as 90% of the time.

>>Outwit the S&P in 2013 With 5 Hated Stocks

Every week, I take an in-depth look at big names that are telling important technical stories. Here's this week's look at the charts of five high-volume stocks to trade for gains.

General Motors

News that the Uncle Sam was exiting is position in General Motors ( GM) provided a big 6.6% move in the stock yesterday, pushing shares through a resistance level at $26, and triggering a bullish setup in shares. This is one perfect example of the technicals leading the fundamentals in the real world. And it's an example of a stock that could have further to run before the calendar flips over to 2013...

That's because GM had been forming an ascending triangle pattern, a setup that's formed by horizontal resistance above shares and uptrending support below them. Essentially, as GM bounced in between those two technical price levels, it was getting squeezed closer and closer to a breakout above that $26 resistance level. Yesterday's news gave traders that breakout.

Obviously, GM is a good distance above that resistance line thanks to the gap we saw yesterday, ramping up the risk a little today. And sure enough, we're seeing a bit of a throwback early in this morning's session. That's not necessarily a bad thing -- $26 is the nearest support level for shares, so if you're looking for an ideal place to buy GM here, I'd recommend waiting for the next bounce higher.


We're seeing the exact same setup in shares of AT&T ( T) right now, except that T's ascending triangle isn't as far along yet.

Like GM, AT&T has been forming an ascending triangle pattern for the last month and change, bouncing in between a horizontal resistance level at $34.50 and uptrending support below shares. Even though this particular setup isn't textbook because it's coming in after a downtrend (typically, ascending triangles come after upside as with GM), the trading implications are exactly the same. We'll want to be buyers on a move above that $34.50 upside barrier.

Momentum adds some extra confidence to this trade right now: 14-day RSI has been in an uptrend since AT&T found its bottom. Since momentum is a leading indicator of price, that's a bullish signal for this setup. Even so, it's critical to wait for that $34.50 price to get taken out before putting your cash on the line. After that, consider a protective stop under the 200-day moving average.

Johnson & Johnson

It's been a challenging year for Johnson & Johnson ( JNJ) -- even though shares of the healthcare product behemoth has seen its shares climb 7.7% since the start of 2012, the S&P has climbed almost twice as much. And now, JNJ could be getting ready to erase some of its already-trailing gains thanks to a double top pattern that's shaping up in shares.

The double top is a pattern that's formed by two swing highs that top out at approximately the same price level. They're separated by a trough, a level that marks the trigger point for this trade. For Johnson & Johnson, that level comes in just above $68; if shares slip below that price, then this trade has triggered, and it's time to be a near-term seller (or a short it). If you're wondering about this pattern's efficacy, just take another look at the AT&T chart we already saw: it was a double top back in October that sent T into the downtrend it's just now recovering from.

When you're looking at any technical setups, it's important to think of them in terms of buyers and sellers. For JNJ, those two tops stalled out at a price where sellers became much more eager to sell shares and take gains than buyers were to buy. And while buyers were wiling to step in and halt the decline just above our $68 level, a print below that line means that increasingly anxious sellers have overpowered them.

This isn't a long-term downside setup for JNJ, but the trading implications are big enough to warrant keeping a close eye on this stock. That's especially true if you're thinking about planning an exit for tax purposes before year-end.

Merck & Co.

Another healthcare setup that's having some challenges right now is pharmaceutical giant Merck & Co. ( MRK). While Merck has beaten the market year-to-date, the setup that it's currently forming could erase all of those gains pretty quickly. Here's why...

Right now, Merck is forming a head and shoulders top, a price pattern that indicates exhaustion among buyers. The head and shoulders is formed by two swing highs that top out around the same level (the shoulders), separated by a bigger peak called the head. A breakdown below the pattern's support level, called the neckline, triggers the sell signal for this stock. Just remember that until the breakdown below $42 happens, there isn't a trade to take here.

Even though the broad market is pointing up, JNJ and MRK are sporting conspicuous bearish setups. That's a big signal for investors to pay attention to, especially with scores of other stocks breaking out right now. Healthcare as a sector is looking a lot weaker than others (early cycle, liquidity-driven names are the strongest right now), so caveat emptor if you're looking at a healthcare buy before year-end.


Finally, Google ( GOOG) is showing traders the exact opposite pattern right now. The inverse head and shoulders is exactly what it sounds like: it's a head and shoulders top that's been flipped upside down. Naturally, then, it's an upside setup.

For Google, the pattern is smaller than the one in Merck -- that means that the trading timeframe is a bit shorter too. More importantly, GOOG broke out above its neckline on Monday, signaling a buy in this stock just as big indexes are going to test their 52-week highs this winter; Google's on track to do the same. Shares haven't made much of a move off of the neckline yet, a fact that makes to day a good buying opportunity. If you decide to jump into Google here, I'd recommend a protective stop right at the 200-day moving average.

Lest you think that the head and shoulders is too well known to be worth trading, the research suggests otherwise: a recent academic study conducted by the Federal Reserve Board of New York found that the results of 10,000 computer-simulated head-and-shoulders trades resulted in "profits that would have been both statistically and economically significant."

That's a good reason to pay attention to the setups in GOOG and MRK right now.

To see this week's trades in action, check out this week's Must-See Charts portfolio on Stockpickr.


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At the time of publication, author had no positions in stocks mentioned.

Jonas Elmerraji, CMT, is a senior market analyst at Agora Financial in Baltimore and a contributor to
TheStreet . Before that, he managed a portfolio of stocks for an investment advisory returned 15% in 2008. He has been featured in Forbes , Investor's Business Daily , and on CNBC.com. Jonas holds a degree in financial economics from UMBC and the Chartered Market Technician designation.

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