When traders look at a price chart, they are trying to spot a pattern that might be similar to one they’ve seen in the past. They believe that history tends to be repeated.

While history never repeats itself exactly, it is often close enough to deliver profitable trading signals, and I am seeing one right now that could make traders triple-digit profits.

First, let’s talk a bit more about patterns.

[ad#Google Adsense 336×280-IA]A head-and-shoulders pattern, for example, is commonly seen at a top.

There is nothing mysterious about this pattern since it simply illustrates market exhaustion.

The left shoulder and the head are part of a normal uptrend with rising prices reaching new highs.

The right shoulder is a warning that the trend has run out of strength, and the failure to make a new high after a short down move is the first signal that prices are reversing.

History shows that this happens quite often, although no two patterns will look exactly alike.

Other patterns follow that same general principle and there are logical reasons why they should work. The four-year presidential cycle is a pattern that is based on politics and it has been working very well in the past few months.

The driving idea behind this cycle is that presidents will make less popular decisions in the first two years of their term when there is less concern about the next election. Those tough calls should work to improve the economy and economic growth in the last two years of a president’s term, which should push stock prices higher.

This pattern can be used as an input in creating annual price forecasts. It can also be broken down to develop monthly, weekly and daily forecasts. The four-year cycle offers a useful roadmap although traders should use this indicator as only one input into their trading decisions.

In the chart below, the four-year cycle has been overlaid onto daily prices of PowerShares QQQ Trust (NASDAQ: QQQ).

This simple pattern told traders to expect a short-term top on the day after the election and prices have followed the general trend of the forecast since then. This cycle cannot be used to predict exact prices, but it does show that a new post-election high was expected in mid-December, followed by weakness into the end of the year and a strong uptrend through January. Those predictions worked well. Prices are set to peak on Jan. 31, according to this cycle, and move lower through the end of March.

I think it is important to pay attention to this indicator as the markets are showing signs of exhaustion after a sharp run up that started at the beginning of the year. The four-year cycle is pointing toward a market decline when many standard momentum indicators are overbought. Overbought markets eventually sell off, and QQQ could be set up for that sell-off to start now.

Buying put options is a lower-risk way to profit from an expected market decline. Puts are considered low risk because traders can limit the amount of money they are willing to risk on the trade. You can never lose more than you pay for the option, an amount that I think I can be limited to $125 on this trade.

Options on QQQ expiring on March 16 with a strike price of $66 are trading at about $0.90. Options contracts are always for 100 shares of stock, so the total cost of this contract would be about $90. The initial price target on this trade is the lower Bollinger Band on a weekly chart of QQQ at about $62.30. If QQQ falls to this level, then the option would be worth at least $3.70. What’s more, I believe QQQ could fall even further than that in the next six weeks, which makes this a conservative target.

Recommended Trade Setup:

— Buy PowerShares QQQ Trust (NASDAQ: QQQ) March 66 Puts at $1.25 or less
— Set stop-loss at $0.50
— Set initial price target at $3.70 for a potential 196% gain in six weeks

Amber Hestla-Barnhart


Source: ProfitableTrading