It's rare to see an extremely clear chart pattern develop. Usually, there are multiple interpretations of price action, so traders often pick the one that fits their bias. That is a recipe for trading disasters in many cases, as the bias wins out over the weight of the evidence. Clear patterns make it difficult to introduce a bias into the analysis and that increases a trader's chances of success.
We have clear patterns forming in major stock market indexes, and the patterns are uniformly bullish. My favorite chart right now is the chart of PowerShares QQQ Trust (NASDAQ: QQQ), which shows a cup-and-handle pattern forming.
The cup-and-handle pattern was popularized by William O'Neil and Investor's Business Daily in the 1990s. It was the favorite pattern of momentum traders who used O'Neil's CAN SLIM trading method. It's a simple pattern that generally serves as a consolidation during a longer up trend. Despite a lot of doubters, QQQ has been in an uptrend for more than three years -- up about 175% from its 2008 bottom.
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To qualify as a cup-and-handle pattern, the base should form through at least seven weeks, with most bases taking three to six months to fully form. QQQ has formed its base within 19 weeks, or about five months. The 12% decline from the top may not be deep enough for pattern purists who look for a drop of at least 15%. O'Neil recommended calling shallow consolidations a flat base. No matter what you choose to call them, both patterns have the same measuring implications.
The depth of the pattern, $8 in this case, can be added to the top of the pattern to identify the price target. From the recent price, QQQ offers a target of $76 and a potential gain of about 12%.
More important than the potential gain is the fact that this is a leading market index that offers valuable market insight. If QQQ is rising, then it's a bullish sign and traders should be more aggressive.
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Aggressive strategies, in my mind, usually include options. In deciding at which expiration month to look, I consider the presidential election in November, which could have a big effect on stocks. Options with an expiration date in November are likely to participate in any election related moves. A number of calls are available with November expirations, but the $74 call option offers the biggest potential gain if QQQ reached the $76 target price. November $74 calls are trading at about 28 cents. If QQQ reached $76, then the call will have an intrinsic value of $2 and deliver a gain of 614%. Options with different strike prices offer lower percentage gains, assuming that the trade is closed at the target price.