Potential Explosive Pattern in the Making

Late in the trading day yesterday, a recent IPO, Ruckus Wireless (RKUS), exploded higher to new all-time highs on very strong volume.  The stock was mentioned on Twitter and StockTwits as the move was happening.  The stock was put into focus on Monday evening by CNBC's Jim Cramer on his show Mad Money.

Here's Cramer's take on the company:  Cramer video

The high, tight flag pattern is a rare occurrence in the stock market, and is often misinterpreted by chartists.  The pattern was introduced in William J. O'Neil's excellent book, "How To Make Money In Stocks".  In the book, O'Neil explained how he traded Syntex after it introduced the birth control pill.  He also gave several other chart examples of the pattern.

Here is O'Neil's description of the pattern from his book: 

"A high, tight flag price pattern is rare and occurs in no more than one or two stocks during a bull market.  It begins by moving approximately 100% to 120% in a very short period of time (four to eight weeks) and then corrects sideways, usually in three, four, or five weeks, no more than 10% to 20%.  This is the strongest of patterns, but it's also very risky and difficult to interpret correctly.  Many stocks can skyrocket 200% or more off this formation."

RKUS is extended from it's most recent brief consolidation, so it's not smart to chase the stock here.  But watch it closely to see if it can settle into a tight sideways base. 

The chart below is merely a projection of how I would "like" to see it play out over the next few weeks.  A few weeks of tight price action to allow the stock to shake out some weak hands leading up to the earnings release in February could set the stock up for a new run to more highs. 

As ALWAYS, use stops to protect your portfolio from big losses.

Click on chart to enlarge.