Follow These Rules to Profit from This "Trading Range" Market as Earnings Come Out

My glasses almost fell off my face Monday night when I read this headline from Bloomberg...

"ETF Investors Are All-In on Stimulus with $17 Billion Stock Bet"...

That's right. Investors have pumped more than $16.5 billion into stock exchange-traded funds in just seven trading days in April.

The article stated that the "torrid" pace put inflows on track to exceed December's monthly inflow total of $42.5 billion.

Talk about a crowded trade...

What's happening right now is a toxic combination of analysts saying, "The bottom's been put in!" and also, "Buy the dips!"

Yes, you can start to buy in. Slowly. Use dollar-cost averaging and buy in increments.

But going all in... well, there's a reason the great Wayne Gretzky said to skate to where the puck is going, not where it has been...

That's exactly why the last time I saw this happening, in December, I bought puts. And they paid off heavily in January and February, such as my 47.87% January gain on FedEx Corp. (NYSE: FDX) and my 108.57% February gain on Tilray Inc. (NASDAQ: TLRY).

The truth of this market is that there's still too much uncertainty, fundamentals are questionable, and technicals are pointing to the downside.

This type of long bet - with people throwing money into the market with coal shovels because it's been climbing for a few weeks- tells me one thing: We're still in the first stage of the market pullback.

So instead of going all in, you trade. Just like I did before. And when you follow these trading rules, you can profit...[mmpazkzone name="in-story" network="9794" site="307044" id="137008" type="4"]

First, Watch Earnings Closely

Investors are rationalizing what's happened here. They want to be in, so they believe what they want to hear.

It's what former Fed Chair Alan Greenspan called "irrational exuberance." Investors are so confident the worst is over, they buy in and lose sight of the underlying problems.

Meanwhile, traders are nervous. The lighter volume on Monday shows that they're unwilling to take the lead in this market, which is very important. The SPDR S&P 500 ETF Trust (NYSEARCA: SPY), the ETF that tracks the S&P 500, had less than 100 million in volume on Monday. We haven't seen it that low since before this decline. Traders don't want to put their money on the table.

They want some more information on where we're headed - and we're about to get a closer look at that with earnings, which have started to come out. We heard from JPMorgan Chase & Co. (NYSE: JPM), Roku Inc. (NASDAQ: ROKU), and Johnson & Johnson (NYSE: JNJ) Tuesday morning, for starters.

Here are a few key takeaways from what I've seen so far...

Companies will withdraw their 2020 guidance. That's what Roku did Tuesday morning, and I expect we'll see a lot more of that in the days and weeks ahead. There's just too much COVID-19 uncertainty for companies to tell you what's going to happen. They can't - so they won't.

This will be a "kitchen sink" quarter. CFOs like to deliver their bad news over time, let it trickle out so it doesn't spook investors. But they have a rare opportunity right now, with shareholders and traders already expecting the worst. Earnings can look horrible because that's what's expected. So they're going to throw it all in. It's like parents expecting Ds and Fs on their kids' report cards - they'll be happy with a C, when normally that wouldn't cut it. Beware of "C" news that looks good only because of the beaten-down expectations.

There's one key number to watch: provision for credit losses. On Tuesday, JPMorgan said it all with its provision for credit losses, which climbed $6.9 billion from the prior year. In other words, it's looking for bonds out there and saying this is how much we think we're going to be losing. There's something important in this number - it's the one number giving you forward guidance. This is JPM saying, "This is what we think will happen over the next quarter." So that's what we need to be watching.

How traders react to earnings will be one factor that determines if we get out of the trading range we've been in, with resistance at 2,800 for the S&P 500, and support at 2,650. That's 280 and 265 on the SPY.

Whether the S&P 500 can stay above the 2,800 mark or not is something we'll soon find out.

In the meantime, here's how you can trade for profits now.

The Rules to Trading This Market

  1. Focus on short-term profits: This market is all about quick trades and fast profits. Look for a 20% to 25% gain on stocks and trades - maybe 50% on the high end when using options - and plan to get in and get out.
  2. Maintain protective puts: We're far from May expiration for options, and the lows are still in play. There's plenty of time for the market lows of March to be tested.
  3. Watch the small-cap sector for leadership: Small caps tend to lead the market. If they go up, most will follow - same with if they fall to the downside.
  4. Do not get swept up in the pattern of jumping into financials after earnings: A lot of financials report earnings this week. They usually rally afterwards and then fall back a week or two later. Financials are no longer the stocks leading the market. Look to small caps as well as the Nasdaq 100.
  5. When considering stocks to buy and trade, look for two trends: Find stocks with high short-interest and those breaking above key technical levels. I like to find stocks that are breaking out above the 20- or 50-day moving averages (see my list below).
  6. If you ARE buying stocks, move in slowly: Use dollar-cost averaging so you buy in increments. And always use a trailing stop. Give that stock a safety net below it.
  7. Look for a stock where the trend is its friend: Zoom Video Communications Inc. (NASDAQ: ZM) is still one of those stocks. It's up about 17% since I first told you about it when it was sitting at $120 - and still going higher.

To get you started, here's a list of stocks breaking above their 50-day moving averages - a key sign that they have the momentum to keep climbing:

A stock that is breaking above its 50-day moving average, and also sees the 20-day and 50-day trending higher, is a perfect signature for a bull market stock in the midst of a bear market.

Today I'll show you the ones that are breaking above these technicals and also have high short interest. That's your best combo for finding stocks to be bullish on now. Just tune in at 8:45 a.m. for those stocks on our Markets Live with Money Morning streaming page, where you can catch me tracking markets in real time. See you then.

And in the meantime, don't forget to check out my colleague Tom Gentile's latest move for making quick cash and long-term growth potential...

You see, America's No. 1 Pattern Trader, Tom Gentile, just recently collected over $14,000 himself, doing it straight from his phone.

Now he's looking to potentially make $120,000 on a boatload of shares he's dying to own.

All thanks to Microsoft.

It's definitely a unique scenario. Go see it in action...

Follow Money Morning onFacebook and Twitter.

About the Author

Chris Johnson (“CJ”), a seasoned equity and options analyst with nearly 30 years of experience, is celebrated for his quantitative expertise in quantifying investors’ sentiment to navigate Wall Street with a deeply rooted technical and contrarian trading style.

Read full bio