Here's How You Book Gains While the Stock Market Gets "Hammered"

The stock market just dropped the hammer on investors.

But don’t worry—that doesn’t mean what you think. In fact, this hammer could score you some lightning-fast, double-digit gains. Let me explain…

You already know a handful of winners have smoke-screened the ugly performance of most stocks lately. And after a dismal 5-day losing streak, investors are shaking their fists at a market that just can’t find its way this year.

But the major averages were solidly in the green yesterday. And that bounce is offering us a scintillating opportunity hardly anyone else will seize…

We’ve waded through the garbage dump market and picked through the scraps. And a couple of worthy candidates have emerged from yesterday’s rally.

And like I said, no one has picked up on these trades yet. The financial media is too distracted by a Chinese farmer who lost all his money trying to trade stocks (at 5x leverage no less). And every other investor is still hiding under his desk after last week.

This opportunity begins with a hammer. And no, not that kind of hammer…

To a trader, a hammer is an important candlestick formation. Here’s your down and dirty description: A hammer occurs when a stock takes a huge dive at the open, then recovers and plows higher towards the close. What results is a hammer-like shape with a long lower “wick” on the candle. And guess what? That’s bullish.

A hammer means one thing: All the sellers have been flushed out and buyers push the stock higher into the close. And when a hammer occurs at an important support area after a big swoon, you should pay close attention.

That’s exactly what we saw with one group of stocks yesterday.

I’m talking about small-caps. The Russell 2000 small-cap index hammered out a tradeable bottom right at its 200-day moving average Tuesday afternoon. These small-cap stocks haven’t exactly enjoyed a bullish run lately. After hitting new highs in late June, the Russell has taken a back seat to the major averages.

But this bounce at the 200-day moving average might have legs. The charts don’t lie:

Even from this simple line chart, you can clearly see the bounce right at the 200-day moving average. Is this bounce for real? We’re willing to take that chance. If we’re wrong, we’ll make run for it. But we can’t let an opportunity like this slip through our fingers…

Playing a potential bounce like this one is the perfect risk-reward scenario. If we’re right, we book the gains. And if we’re wrong and the bounce doesn’t hold, we have the option to sell almost immediately with minimal losses.

It’s time to break out the hammer…

Greg Guenthner

for The Daily Reckoning

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