Market Outlook: If You Could Only Choose One Investment, This Would be It

Traders seem to like the Fed's decision to implement QE3 and boosted the prices of both stocks and gold. There was one very big winner in QE2, and now it's time to buy that ETF again.

Stock Prices Jump on Fed Easing

For the second week in a row, SPDR S&P 500 (NYSE: SPY) gained more than 2% last week. Also for the second week in a row, PowerShares QQQ (NASDAQ: QQQ), an ETF that tracks the 100 largest Nasdaq stocks, lagged SPY and delivered a gain of only 1.08%. Many traders believe that in a healthy bull market the most speculative stocks will be the biggest winners, and QQQ should be the better performing index under that theory. This is a possible signal that stocks may be ready for a pullback.

A pullback would be consistent with the election cycle, which indicates a weak stock market into early November. That indicator calls for a peak in most major stock market indexes this week. Alone that is not enough to generate a sell signal, but the chart of QQQ below does provide enough bearish indicators to justify tightening stops on long positions.

Bollinger Bands have been added to the price and the upper band has been set to 2.5 standard deviations rather than the standard value of 2 standard deviations. At the close on Friday, QQQ was more than 2.5 standard deviations above its 20-day moving average, an event likely to occur less than 1% of the time. Because it is rare, there are few examples of this to test, but 80% of the time (8 of 10 trades since 2007), QQQ was lower a month later.

In addition to being overbought based on the Bollinger Bands, the stochastics indicator has formed a negative divergence with lower values accompanying new highs in price.

While a pullback would not be unexpected, QE3 is bullish for the longer term. A chart included in last week’s market outlook showed that stocks have moved higher in the past when the Fed is easing. With the Fed planning to commit at least $480 billion to QE3 during the next 12 months, if stocks rise only half as much as they have under QE1 and QE2, we should expect a gain of about 10% in SPY. Of course, prices could follow a different path this time and we should trade the trend we see in the charts rather than what the news stories tell us to expect.

Recommended Trade Setup:

-- Raise stop-loss to breakeven level at $68.60
-- Set price target at $76

Silver Could be the Precious Metal to Trade

QE has been bullish for gold in the past and traders holding SPDR Gold Trust (NYSE: GLD) should see additional profits. They enjoyed a gain of 1.99% last week. Based on the charts shown in last week's market outlook, we could expect to see a gain of about 32% in GLD if the effects of QE are consistent with what we saw in the past. There is, however, the chance for an even bigger gain. During QE2, silver delivered bigger gains than gold, and silver miners outperformed both metals.

In the first days of QE3, we are seeing the same pattern. iShares Silver Trust (NYSE: SLV) outperformed GLD last week with a 2.94% gain. Global X Silver Miners (NYSE: SIL) did even better with a gain of 8.23% for the week, and based on history, there should be more gains ahead for both of these ETFs.

Traders should continue holding GLD, and if trading capital permits, add SIL to their portfolio. If forced to choose just one position in the precious metals market, SIL should be the biggest winner.

Recommended Trade Setup:

-- Raise stop-loss to $163.69
-- Raise price target to $178.92, the upper Bollinger Band on the monthly chart

-- Buy SIL at the market price
-- Set stop-loss at $22
-- Set initial price target at $32.68