One of the biggest challenges traders face is usually the challenge that comes from within.
Specifically, the inability to overcome one’s emotions, especially fear and greed, is often what causes so many to fail in this business.
This new generation of traders has been spoiled by an environment of extreme liquidity that has fostered one of the longest stretches in history without a correction of just 5% in the benchmark S&P 500.
But there have been a number of meaningful corrections in other widely followed corners of the market that have acted as a firm reminder to traders that markets don’t always go up.
The correction we’re going to look at today has been so slow and steady that it lacks the “sexy” factor that the financial media demand to be headline worthy. At the same time though, this correction has formed one of my favorite patterns that, if confirmed with a breakout, would create one of the biggest trading stories of the year.
Corrections come in two forms: price and time.
When we talk about a correction in price, we’re typically talking about a steep, sharp drop in price.
Figure 1 below, on the other hand, shows a perfect example of the other type of correction, a correction in time.
Specifically, Figure 1 shows the Russell 2000 Small Cap ETF (IWM) near the end of a multi-month price range, which has taken the form of an “ascending triangle,” and in the process has allowed its long-term average (the 200-DMA) to catch up.
Time-based corrections such as this are usually viewed as being healthy because the orderly, sideways price action is a sign that there was not a lot of heavy panic selling during its formation.
Small caps were strong out of the gate in 2021 as the risk-on, high-beta narrative continued after jumpstarting in early November of last year.
By mid-March, small caps were actually ahead of large caps by about 14% before mega caps regained leadership.
A small cap breakout would be a healthy signal that introduces new trading opportunities
When small cap stocks are performing well, it is viewed as an indication that the overall market is healthy, as these smaller companies are often less well funded and can have riskier business models.
Therefore, a breakout in this market segment, should it occur, would indicate that there has been some much-needed improvement in market breadth and confidence.
In addition, it would bring improved liquidity and greater interest to a different set of sectors.
Specifically, Figure 2 below shows the IWM sector weights, where Health Care is the top-weighted sector.
Next, Figure 3 shows the top 10 holdings within IWM.
Sticking with the Health Care theme, I then focus in on the stock with the 2nd highest weighting, the Healthcare company Intellia Therapeutics (NLTA), to see if the stock is showing a strong technical setup with favorable risk/reward parameters and a high probability of success.
As Figure 4 shows, NTLA surged earlier this summer when the company released interim data from the Phase 1 trial of its collaboration with Regeneron on an experimental therapy for transthyretin amyloidosis (ATTR) – a protein misfolding disorder.
Since then, the stock has been consolidating in what can be described as a “saucer” or “cup & handle” consolidation pattern that, if confirmed with a close > $178.00, would produce measured potential to roughly $222.50 per share, which is another 27% of upside potential from Friday’s closing levels.
The other key aspect to this setup is the well-defined protection at the most recent pivot low of $152.06.
Specifically, since a critical part of my thesis for this trade is that I want to benefit from a continued uptrend in shears of NTLA, that tells me that the stock price simply cannot fall back below the most recent pivot low at $152.06 (see Figure 4) anytime soon, as this would negate the current uptrend.
I like this setup for the following reasons:
- I’ll only be risking 1 on the downside to make 2 on the upside
- I am placing the trade in the direction of the trend
- Momentum is in a bullish regime
- There is a large, resistance-free air pocket ahead of the potential target
- The stock is in a sector that is poised to outperform in the event of a Russell 2000 breakout
- Corporate earnings risk is not a factor until mid-November