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Contrarians love a good scandal. When a stock drops hard for no other reason, it often presents the chance to play the rebound for a quick profit. That seems to be the case with banking giant Wells Fargo (NYSE: WFC).
On Sept. 9, news came to light that employees had been opening illegal accounts in an effort to meet sales targets and earn bonuses, and the stock got slammed. Of course, it didn't help that the market tanked that day on rather hawkish comments by the Federal Reserve.
Interestingly, though, while the stock was severely punished for its foibles, falling 9% in just over a week's time, analysts have not lowered their ratings on the stock, with the majority still considering WFC a "buy." And with interest rates likely to start moving higher, the entire banking sector stands to benefit from a friendlier lending environment.
A look at the KBW Nasdaq Bank Index (BKX) shows the sector setting a new high for the year early this month and finally outperforming the broader market. Wells Fargo, on the other hand, stalled last month right at resistance from earlier peaks in 2016. This set up a sizeable trading range for the year.
The recent sell-off sent the stock tumbling down to the lower reaches of that range and pushed momentum indicators like stochastics into oversold territory. I like to use stochastics on this pattern since the indicator tends to work well in flat markets and trading ranges.
Sentiment seems to be getting even worse, and outspoken bank critic Massachusetts Senator Elizabeth Warren wants to take the scandal straight to the top management of the bank. Despite a $185 million fine, it seems that some will only be satisfied with the head of CEO John Stumpf on a platter. Yet, even to a chart watcher like me, that seems to be more perception than business need. There have been no major restructurings, no big write-downs and no mass exit of customers.
This extreme negative sentiment sets up the perfect environment for a contrarian play.
Technically, there is a good deal of support at the 2016 lows near $44.45. While the heightened emotion surrounding the stock could take it slightly below that level, it is already close enough that the dollar risk should be low.
Oversold conditions, extreme negative headlines and proximity of support make this an attractive trade. Relative strength in the banking sector despite overall market weakness adds to the bullish argument.
Look for a rally back to the top of the trading range, assuming the market itself does not crater here.
If the stock is going to snap back as sentiment shifts, though, it should happen fairly quickly. And I would bail out before resistance at the top of the trading range is reached.
Recommended Trade Setup:
-- Buy WFC at the market price
-- Set stop-loss at $43.25
-- Set initial price target at $50 for a potential 9% gain in four weeks
Note: If you are a bit squeamish about buying stocks during the traditionally weak September-to-early-October period, especially in an election year, then an alternative strategy may be your best bet. This strategy risks a fraction of the capital you would if you were buying shares outright and can return 5-10 times as much. Learn how here.
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