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Pundits have been making a big deal out of the S&P 500's tight range over the past few weeks. That's because this type of pattern typically sets the index up for an explosive move when it finally breaks out of the range.
The same pattern can easily be spotted on the charts of certain individual stocks as well. Right now, convenience store chain Casey's General Stores (NASDAQ: CASY) sports a tightening range with two catalysts on the horizon that could ignite a breakout.
The first is this morning's August jobs report. The next is the company's quarterly earnings announcement, which is scheduled to be released on Tuesday.
Now, we cannot tell from a tight range alone which way the stock wants to move. If the market likes the jobs report and/or Casey's surprises to the upside with its earnings report, the breakout should be higher. If the opposite occurs, we can expect shares to break lower.
Therefore, for today's trade, all we need to know to increase our chances of success is what constitutes a breakout from the range.
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As the theory goes, volatility cycles from high to low and back to high again. The uncertainty inherent in a trading range eventually resolves as market participants finally come to an agreement on how they feel about the market or a stock, whether it's bullish or bearish. Pent up buying or selling is released, and prices start to move quickly.
As we can see in CASY's chart, the stock stalled in July and began to trace out a contraction pattern known as a pennant.
Normally, such a pattern after a rally would lean bullish. Pennants, triangles and the like are more often continuation patterns than reversals. However, any technical pattern can result in a continuation or a reversal, so it is always critical to wait for prices to move out of the pattern before taking action.
While it's hard to knock a stock that is in a holding pattern near all-time highs, there's one factor that is troubling. Sentiment is decidedly bullish with the overwhelming majority of analysts rating the stock a buy and none rating it a sell.
Such extreme bullish sentiment is actually bearish. It suggests that everyone who is interested has already bought the stock. This sets it up for a drought of new demand, leaving it unable to withstand bad news.
On Thursday, CASY closed right at the pennant's lower border. The indicator at the bottom of the chart is Bollinger Bandwidth, which measures how narrow the bands are. Bollinger Bands are based on volatility, so narrow bands mean the stock is less volatile. The longer the bands remain in this state, the more likely the stock will move sharply to widen the bands.
As we can see, bandwidth is significantly below the average low levels on the chart, and that makes it more important than usual. A breakout one way or the other seems imminent.
A sell signal will be triggered if CASY falls below $131. Traders can pounce on this for a short trade that could land them double-digit profits in a matter of weeks.
Conversely, if shares break out to the upside, a buy signal will be triggered with a move above $135.25, which could result in a double-digit bull run.
Recommended Trade Setups:
-- Sell CASY short below $131
-- Set stop-loss at $135
-- Set initial price target at $118 for a potential 10% gain in six weeks
-- Buy CASY above $135.25
-- Set stop-loss at $131
-- Set initial price target at $149 for a potential 10% gain in seven weeks
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