Technical and quant analyst Jim Stanton says he has developed a trading system – the 1-2-3 Trader – that has so far brought in cumulative profits of 591%. Here he explains how he applies this system to the energy sector…

In my last “Sector Watch” column, I pointed out that crude oil futures had generated a daily sell signal and, in keeping with the sector ETF analysis that I do here, the way to play the oil market was by using the U.S. Oil Fund (AMEX: USO) – the ETF that tracks the performance of West Texas Intermediate (WTI) light, sweet crude oil by investing in futures contracts for WTI, as well as other types of crude oil, heating oil, gasoline, natural gas and other petroleum based-fuels.

So what did the “code” tell us?

Quite simply, the way the daily chart pattern looked, USO was tracing out at least an A-B-C (or 1-2-3) Elliott Wave Theory correction.

This means that the initial drop is the “A” (or “1″) wave down, followed by a “B” (or “2″) wave rally, then finally, a “C” (or “3″) wave decline to new correction lows.

This forms just one of the three parts of the system that I use to accurately pinpoint index and stock movements, so I can guide my readers toward profits.

But it’s also really as easy as “1-2-3.” Which is why I decided it had to make up the name of my trading service – the 1-2-3 Trader.

As for USO, the stock was trading above $99 when I last wrote to you two weeks ago. Today, however, it’s fallen to around $91.50.

If you want to play USO, the good news is that it’s still in the “A” (1) wave down, which means that we’re still waiting for the “B” (2) wave rally to begin – the point where we can initiate a put position.

Now onto this week’s highlighted stock…

An Opportunity To Profit From Oil’s Partner In Crime

In last Thursday’s Smart Profits Report, I showed you an example of how the pattern recognition component of my system generated a profitable trade on Harley Davidson (NYSE: HOG).

Specifically, we bagged a 112% gain in less than a month.

The very same “1-2-3″ system also churned out three other winners…

• An 80.4% gain in just three days on Boeing
• An 89.1% gain in a week on Coca-Cola
• A 53.4% gain in a day on Federal Express

As good as those profits were, they’re in the past now. It’s time to show you how the pattern recognition component of my system can predict what’s going to happen in the future.

Take a look at the daily chart of the U.S. Natural Gas Fund (AMEX: UNG) – the ETF that reflects the performance of natural gas prices. Whenever possible, I like to look at other stocks in the same sector to confirm my analysis and UNG has a very similar chart pattern to USO.

Yes, UNG has undergone a much larger correction than USO, but the chart patterns are almost identical.

The 1-2-3 Way To Profit From Natural Gas

Since reaching its high of $63.89 on July1, UNG triggered a daily sell signal and has fallen by more than 35%.

Once a sell (or buy) signal is triggered, my trading system calls for at least a three-wave move.

 

As you can see, the current chart pattern suggests that UNG is still in the “A” (or “1″) wave of the selloff, and when the initial selling is complete, a “B” (or “2″) wave rally should get underway.

 

Right now, there is no way to tell for sure if the “A” wave is complete, or how high the “B” or “2″ wave will go when it gets underway. But we can say one thing:

 

Assuming that no damaging hurricanes enter the Gulf of Mexico, when the inevitable, counter-trend rally begins, I would buy put options on a retracement of 30% to 50%.

 

And an important word of warning: When trading the short side of the energy markets during hurricane season, it is very important that you only use put options.

 

While you may be tempted to short the stock in question, the risk is just too high. Put options limit your risk, which is necessary this time of year.

Source: How to Crack the Market’s Code