In a world where the government pays only 3.1% to lock up money for 30 years, it’s nice to find a stock that yields twice that much with double-digit appreciation potential. I’ve written about oil giant BP (NYSE: BP) several times, but a setup is a setup — the market doesn’t care how many times we go to the well.
Energy is one of the so-called Trump sectors that will supposedly be unleashed as regulations and restrictions are lifted. Of course, some will counter with the argument that the world still enjoys ample supply and prices will therefore not advance much higher.
And, in the end, the market will show us.
Right now, the market is telling us that the oil sector is feeling feisty and BP, in particular, looks ready to break out to the upside.
Let’s start with the sector using the Dow Jones U.S. Integrated Oil & Gas Index as a proxy.
The index peaked in July and traded back down to begin tracing out a cup-and-handle pattern.
In simple terms, the pattern describes what happens to a strong stock as it rests and then prepares to resume its bull run. Price action forms a cup shape with a rounded bottom and then climbs back to its prior high-water mark. The transition should be gradual rather than sharp or excessively choppy.
When shares arrive at resistance from the prior peak, they rest again to form the handle of the cup. It can be a simple pause or can form a small flag pattern, but the point is that the stock seems to be gathering strength before it attempts to break out.
Volume is supposed to form a cup shape as well, with the key point that it increases during the formation of the right side of the cup. The Dow Jones U.S. Integrated Oil & Gas Index saw volume explode exponentially during that phase and also saw volume contract during the handle, as we would expect during any corrective or resting pattern.
All that is left is an upside move through the top of the cup to kick off the next leg of the rally.
In addition to the bullish configuration for the sector, BP also has the wind at its back. The stock is also attempting to break out, although the pattern here is a bit different.
Rather than settle into a cup shape, BP traded sideways after its June peak to form a trading range. Then, on Dec. 14, it sold off at resistance and jumped lower the next day. Without much news, the technical result was very encouraging, as the stock closed near its best levels of the day on Dec. 15. Then it opened the following day 1% higher and stayed strong.
So, the bears had control initially, but the bulls charged in to scoop up shares at the lower price. That told us demand was solid, as did the on-balance volume indicator, which moved to a fresh 52-week high. This indicator keeps tabs on volume changing hands on up days minus volume on down days, and it serves as a proxy for money flowing into the stock.
To be prudent, traders should wait for the actual breakout in BP above the recent range at $37.20. If successful, the next important resistance level doesn’t appear until $43.85, which is the 2015 high. However, the trading range projects an upside target just below that, in the $42 area, which would still result in capital gains of 13%.
Recommended Trade Setup:
— Buy BP at $37.20 or above
— Set stop-loss at $35.30
— Set initial price target at $42 for a potential 13% gain in six weeks
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Source: Profitable Trading