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Any market analyst will tell you that a low price doesn't necessarily signal an undervalued stock. If a stock's trend is down, then the odds are fairly high that it will move even lower. That's why it's critical to wait for a stock to prove it has found its legs.
While doing so makes it impossible to buy at the exact low, the lower risk that comes with confirming the trend makes it worth paying up a little. And right now, telecom giant Verizon Communications (NYSE: VZ) is rising solidly off its lows.
The stock set a 16-year high in July when it poked its head above $56. Unfortunately, that was exactly when interest rates bottomed, and rate-sensitive sectors started to fall in a big way. This included utilities, real estate trusts and big dividend payers like Verizon, which throws off a yield of nearly 5%.
But Verizon's problems went beyond that.
In July, the company's second-quarter earnings were dented by a worker strike. And in October, Verizon beat analysts' earnings estimates for the third quarter but shares fell sharply anyway. In fact, the stock jumped lower at the open on Oct. 20, leaving a gap on the chart. A gap down, especially on good fundamental news, is a rather strong bearish signal.
VZ kept falling until the middle of November -- declining almost 20% in just over four months -- and things suddenly turned around. Weekly charts show a bullish reversal bar last week, as the stock set a new weekly low but closed above the previous week's closing high. So far this week, price action has followed through to the upside, as the stock jumped nearly 3%, confirming that the trend has likely changed for the better.
This kind of movement signals that a battered stock is actually presenting good value. In other words, the stock has proved that it's strong enough to move on more than just the backs of bargain hunters and bottom fishers.
There are supporting technicals, too, such as a bullish divergence between price and momentum. The Relative Strength Index (RSI), for instance, set a higher low in November as price set one last lower low. That tells us selling was waning even before the bullish price reversal.
Another positive factor is that the reversal came above long-term chart support. In chart reading, when a stock fails to reach a support area -- a price level at which we presume traders will get interested -- it tells us that the bulls didn't wait for that last bit of price decline before jumping in. That demonstrates elevated demand, which is hidden from view in most indicators that attempt to measure buying and selling pressure.
Verizon does need to navigate a few more obstacles. For example, the rally has already reached the bottom of the October gap, where people who got trapped in the stock on the way down might decide to get out.
Shares are also in the vicinity of their July trendline and the 200-day moving average, so it wouldn't be a surprise to see them stall here. However, with the weekly reversal still in place, we can allow the short-term condition to work itself out as the longer-term signal remains the dominant force. A breakout after that would sound the "all clear."
For this trade, the stop is only about 3% below the entry price, but that would almost completely wipe out Tuesday's big gain and likely negate the weekly reversal signal.
We'll set our target at $53.80, near resistance from September's small gap down, as well as the larger gap down seen in April.
It's possible this target may be hit before Verizon's next ex-dividend date, which means you'll miss out on the stock's nearly 5% yield. But there is a way to generate an "instant dividend" when you purchase shares. These extra cash payments can total hundreds or thousands of dollars a month depending on how often you collect. Find out how here.
Recommended Trade Setup:
-- Buy VZ at the market price
-- Set stop-loss at $48
-- Set initial price target at $53.80 for a potential 9% gain in six weeks
-- Find out how to collect an "instant dividend" payment here
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