By: Michael Kahn of Street Authority
Trading countertrend moves can be profitable but risky, so it pays to line up as many factors as possible in our favor before putting money to work.
When a stock sports a price-to-earnings (P/E) ratio that even a technical analyst such as me thinks is low, it's worth a look. When it is oversold at support, I'll get interested. And when the price of its main input commodity starts to fall, I'll consider a quick snapback trade.
This is the case with American Airlines (Nasdaq:AAL).
I will admit that as a chartist, looking at fundamentals gives me the willies, but AAL has a trailing P/E ratio of just 3.1. That's not only insanely low compared to the SP 500, which has a P/E ratio of 19.1, but it's less than half of the industry average of 6.3. Even based on next year's earnings, AAL trades at just 5.7 times estimates.
The stock has fallen more than 20% in the past month and a half, but the recent drop in oil prices following a multimonth rally could result in a short-term pop in AAL.
Oil prices cratered 2.5% Tuesday on expectations that U.S. crude inventories hit a new record high. This was the third straight session of losses, and oil prices are now more than 5% off their 2016 highs made last week. But AAL's action on Tuesday leads me to believe this could be a great spot to enter a quick bullish trade.
Turning to the chart, we see that with shares already in decline, AAL gapped down on April 22 after the company reported better-than-expected first-quarter earnings and a share repurchase plan. Bad action on good news is bearish, and it was all downhill from there... that is until Tuesday, when the stock closed well off its lows of the day.
Although small, Tuesday's action left a bullish hammer candle on the daily chart and represents a potential hold of major support from February.
AAL now sits 16% below its 200-day moving average. Over the past year, every time the stock was this far below the 200-day, it rallied back to it in a mean-reversion move. So, this seems like a good place to expect a snapback rally.
To be sure, I am using the moving average as just that -- an average price for the past nine months and not a trading signal. Flat patterns such as the one AAL occupied for the better part of the past year are not conducive to trading with moving averages. However, in this case, it does give us a good idea of where the pendulum should be heading.
AAL may overshoot the 200-day, but at that point it will have lost the power stemming from simply being oversold. Things could change, of course, but with the evidence at hand, I am not willing to bet on anything more than a return to the moving average, and even that may be aggressive.
But the bottom line is American Airlines is oversold at support, and that gives it a good shot for a quick bounce from the depths of its trading range. I am looking for a move to the bottom of the April 22 gap at roughly $38.50 in short order, because that's what snapback rallies are all about.
Recommended Trade Setup:
-- Buy AAL at the market price
-- Set stop-loss at $33
-- Set initial price target at $38.50 for a potential 11% gain in two weeks
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