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Shares of Bank of America (NYSE: BAC) rallied sharply over the past two weeks, as the broader market rebounded with a "V" recovery. The stock looks somewhat exhausted at the moment, but its chart tells me it's a prime candidate for a year-end rally.
Many of the best traders and money managers I know spend a good deal of time analyzing and trading banking stocks. Bank stocks may not be the biggest movers on any given day, but considering how integrated they are with the economic cycle, and in particular, their exposure to interest rates and monetary policy, they can serve as a great barometer for investors' appetite for stocks in general.
There are many ways to monitor risk appetite, from implied volatility indices to credit derivatives. But one of the simplest ways is to focus on the KBW Bank Index (BKX) or the Financial Select Sector SPDR ETF (NYSE: XLF).
More often than not, the stock market has a difficult time sustaining a rally without broad participation from large bank stocks. When this group lags during a general market advance, it is often a sign of underlying weakness and puts the overall rally in question. Conversely, when banking stocks are outperforming, oftentimes the broader market will wake up and join the party.
With this in mind, let's take a look at the weekly chart of the KBW Bank Index, of which BAC is a top holding.
In the bigger picture, 2014's action can be viewed as a consolidation. The sell-off in late September/early October caused BKX to break below its late 2011 uptrend line, but it held the lower end of its consolidation range.
As a result of the sideways move this year, the Relative Strength Index (RSI) formed a series of lower highs, which if broken to the upside, would likely coincide with a breakout in the index past its resistance line.
I remain of the opinion that U.S. stocks are in the middle of a large secular bull market that has at least five, but more likely 10, years left to go. For younger traders, this is the first secular bull market they are witnessing, and they will likely be surprised how well stocks hold up during pullbacks and how quickly they bounce back. Bank stocks are a great way to watch for confirmation that the longer-term bull is alive and well.
The weekly chart of BAC is clearly bullish. The 2014 consolidation period is taking place right below the 2009/2010 highs. An eventual break past these highs will have large bullish implications.
Even during the late September/early October pullback, BAC held its late 2011 uptrend line, and the 2014 consolidation period remains intact and healthy looking.
On the daily chart below, the consolidation resulted in the stock's medium-term moving averages trading close together. Therefore, they are of little use as support or resistance levels. But note how sharply the stock bounced from its May support line in mid-October.
With the recent rebound in the broader market, BAC has almost worked its way back up to its early October highs and the diagonal resistance line from March.
Traders should buy the next dip in the stock for a rally into year end, which should push shares past the diagonal resistance line from the daily chart.
Recommended Trade Setup:
-- Buy BAC on a pullback to $16.60
-- Set stop-loss at $16
-- Set initial price target at $18.50 for a potential 11% gain in 4-8 weeks
Note: One indicator spotted eight of 2014's biggest winners before they delivered gains as high as 266%. It just tagged another stock as a "Top Pick." In fact, the stock is flashing the exact same kind of buy signal as last year's top picks. Click here to get the name of this stock for free.
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