Risk vs Reward Favors Owning CLF

On occasion, the simplest ideas are the most effective. When I sent last Thursday's bonus article to subscribers of my weekly newsletter EPIC Insights I focused on Cliff Natural Resources (CLF). With a trailing P/E of 33, a forward P/E of 13, and a dividend yield of 0.66%, the stock was fairly valued and from a fundamental perspective did not offer a compelling reason to either own or be short the stock. Technical analysis led to the same conclusion: after breaking a long-standing uptrend (black line) in early January, CLF had meandered for weeks.

After dismissing a trade on technical merits, I turned to an event-driven strategy. Having just reported robust earnings, CLF was prepared to rally. Never one to chase a move, I examined the prior earnings announcements and saw an interesting pattern. Each time CLF reported results, the direction of the price movement the next day (blue arrows) started a move that persisted for weeks. Expecting a rally and looking to exploit this tendency, I recommended buying the stock with a $55 upside target.

Currently, CLF trades for $53.66, delivering a 14% return to my subscribers in less than one week, and now sits just over $1 from my initial price target. Pleased with the quick gains, I now focus on what will come. Typically, I would look at the move to within such a small distance from my price target as adequate and liquidate the position. After all, a disciplined approach when determining both when to buy and when to sell has led to our large gains and I see no need to complicate a proven process. However, maximizing gains when minimizing risks has also been key to our success and it is that approach I will apply now.

With the recent rally, CLF is once again above its uptrend. With resistance looming at the recent high of $55, the shares are on the cusp of breaking in either direction. If resistance falls, CLF could easily push to $62. Similarly, resistance holding will push the price lower. However, the existing uptrend should slow the descent and allow us to exit the trade before damage is done.

Combining these scenarios, owning CLF offers high reward with limited risk. A move higher would take the shares to $62 (15%), while a break lower would allow us to exit at $52.50 (2%). To exploit this opportunity, I will add to the current trade and then use a tight stop to contain risk. I recommend increasing the position in CLF. Exit the entire position on a close below $52.50.

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