It’s no secret that breaking news can trigger stocks to make sudden moves in either direction. News catalysts could be updated economic data, geopolitical events, stock-specific news, and changes in market sentiment.
Trading such stocks after they experience sudden volatility is typically considered a high-risk-high-reward venture. However, careful analysis of the charts could help you enter your trade at the right price level, limit your risk, and maximize your profit.
With this in mind, we recently started a weekly series called our “Trending Stock of the Week”. In this series, we feature a stock that’s trending in the news and offering a potentially attractive trade opportunity.
This week’s featured stock is Costco Wholesale Corporation (NASDAQ: COST).
Why is COST trending?
Thanks in large part to pandemic-driven demand, Costco shares have soared since July. The biggest advantage of Costco is its bulk pricing and trip consolidation for customers — which replaces the traditional grocery, department store, and specialty retail. Costco has also been offering an expanding selection and better value for customers, resulting in the company’s higher growth pace.
Costco has a healthy balance sheet, allowing it to afford ongoing investment while preserving operating margins. All of this points to further upside for the stock in the near-term.
Here’s how to trade COST after its rally and recent pullback.
There are multiple bullish indications on the daily chart of COST.
#1 Price Above MAs: The stock is currently above the 50-day as well as 200-day SMA, indicating that the bulls are currently in control.
#2 Uptrend Unbroken: The daily chart shows that the stock’s uptrend is unbroken, as it has been forming higher highs and higher lows for the past several weeks. This uptrend line has been marked as a pink color line. Currently, the stock is nearing the trendline support again, indicating the possibility of an upmove soon.
#3 Near Fibonacci Support Area: The daily chart of Costco shows that it is currently near a Fibonacci support level of the upmove. The Fibonacci levels are marked in blue color lines. The current level seems like a good area for the stock to bounce higher.
Recommended Bullish Trade (based on the chart)
Buy Levels: If you want to get in on this trade, the ideal buy level for COST is near the trendline support, at around $355. This is marked as a green color dotted line.
However, those with a higher risk appetite can purchase half the intended quantity of shares of COST between $363 to $365. This is marked as a yellow color dotted line. The rest of the position can be added if the stock corrects to the trendline support.
Important Note: Make sure that you only enter the trade once the daily close is above the recommended price level.
TP: Our target prices are $385 and $410 in the next 3 to 6 months.
SL: To limit risk, place a stop loss at $338 (for entry near $355) and $350.50 (for entry near $364). Note that the stop loss is on a closing basis.
Our target potential upside is 6% to 16% in the next 3-6 months.
- Entry near $364: For a risk of $13.50, our first target reward is $21.00 and the second target reward is $46.00. This is a nearly 1:2 and 1:3 risk-reward trade.
- Entry near $355: For a risk of $17.00, our first target reward is $30.00 and the second target reward is $55.00. This is a nearly 1:2 and 1:3 risk-reward trade.
In other words, this trade offers 2x to 3x more potential upside than downside.
Risks to Consider: The stock may reverse its overall trend if it breaks down from the trendline support with high volume. The sell-off of the stock could also be triggered in case of any negative news, overall weakness in the market, or any regulatory changes in the sector.
Recommended Bearish Trade (based on the chart)
In case the stock breaks down from the trendline support with very high volume and closes below its previous pivot low, it could point to an upcoming short-term correction. In that case, below are the entry levels, stop loss levels, and target prices.
Sell Level: You can take short positions on COST if it breaks down from the trendline support as well as the previous pivot low. This translates to a price of around $333.00. This sell level is marked as a red color dotted line in the chart.
Important Note: Make sure that you only enter the trade once the daily close is below the recommended price level.
TP: Our target prices are $320 and $300 in the next 3-6 months.
SL: To limit risk, place a stop loss at $341. Note that this stop loss is on a closing basis.
Our target potential downside is 4% to 10% in the next 3-6 months.
For a risk of $8.00, our target rewards are $13.00 and $33.00. This is a nearly 1:2 and 1:4 risk-reward trade. In other words, this trade offers nearly 2x to 4x rewards compared to the risks.
Risks to Consider: The stock may reverse its overall trend if it breaks upwards from the previous pivot low with high volume. The breakout of the stock could be triggered in case of any positive news, overall strength in the market, or any regulatory changes in its sector.
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