Is Bank of America Poised for a Major Move Up?

The stock price of Bank of America (BAC) made an impressive move Thursday moving up 33.5% with more than one billion shares traded. The stock chart of BAC is showing a classic cup and handle pattern which I will discuss in this article.

Price Action Overview

Link to high resolution image

1. The share price started falling in early January. The initial decline from around $15 to $10 did not have a lot of volume. However once the stock broke $10 the share volume increased substantially.
2. The stock made a low of $2.53 on February 20 while trading more than 800 million shares.
3. It started rising from this point on. Once the stock market bottomed in early March, the price rose on increasing volume, making a high of $8.54 on March 19 after a gap-up open which could not be sustained.
4. The stock price then consolidated on falling volume reaching as low $5.91.
5. On April 9^th, the stock broke out of the consolidation on very high volume, closing at $9.55 having reached an intra-day high of $9.85.
6. The stock is trading will above its 50 Day Simple Moving Average which is at 5.8. The 50DSMA is now sloping upwards which is a good sign. The stock is trading well below its 200 Day SMA at 18.46.

Is this Cup and Handle Pattern Breakout a Buy?

BAC’s stock price is matching the classic cup and handle breakout pattern to the tee. However there are some caveats:

1. The $10 price level is a major milestone which the stock has yet to overcome. It marks the November low.
2. In a classic Cup and Handle Buy, the left edge of the cup marks the high point which has to be overcome. In the case of BAC, this level corresponds to the January high of $14.75. One redeeming factor is the fall from that January high to the $10 level happened during the course of a week on low volume. Hence this price region does not offer significant resistance to upward price movement. Investors who bought during the fall in early January, likely sold the stock when it cracked below the $10 level.
3. The breakout today happened during a holiday week which are typically bullish and with a smaller number of market participants active. Most traders will discount any major price action which happens during this period. However, what is unusual about BAC’s breakout is that the numbers of shares traded crossed the 1 Billion mark, perhaps the highest level in BAC’s history.
4. The short interest in BAC decreased significantly from March 13 to March 31. Though this is an indication of greater investor confidence, it is also an indicator that the current move was driven by short covering. It is not clear whether institutions have started patronizing BAC again.

In a normal market the price pattern displayed by BAC would be a screaming buy. However in the current environment with headline risk the answer is not obvious. Before investing in BAC, an investor should keep the following in mind:

1. Let the stock confirm its break out on a regular trading day not affected by a holiday. This means wait till at least Tuesday to see what the market truly feels about BAC.
2. Wait for a confirmed, strong close above the $10 level. This is a level which will start attracting a lot of institutional interest. A few days of closing price above $10 will confirm that interest.
3. Be conscious of the large gap between the 50 Day SMA at $5.8, and the stock price near $10. In typical bull markets, the 50 Day SMA acts as a support point, where institutions typically accumulate more stock. In this case the average is almost 40% below the current price and well above the breakout point.

If BAC’s stock continues the breakout, the potential price targets are around $15 (the January High) and $18 (July 2008 Low).

Closing Note

I have refrained from any fundamental analysis of the bank since the destiny of the US Banks system is being determined in Washington and not on Wall Street. Investors who want to invest in banks, should also consider preferred stock issued by banks. On a purely capital structure basis, the preferred share should be trading at par for the equity to be worth anything. Currently, the preferred shares of most banks are trading at a major discount to their par-value. The ETF PGF is a basket of preferred shares of different banks from world over and is currently trading around the $11 mark. It is definitely something to consider along with the common stock of banks.

Disclosure: Vikram holds long and short options and equity positions in BAC, PGF and other bank stocks.

Comments

[Vikram Saxena:]

Darvania:

The market has thrown out all rules during the past year. Further the scope of the market decline has matched some of the worst bear markets in history. As a result the ratios which may have worked well in the past can not be applied religiously here since the market is not behaving in a manner when those rules were developed and refined.

As I noted in my article, even if we accommodate for stretched ratios, the pattern is not perfect and has to be traded with a lot of caution. However, there is no denying that the 1st order metrics of the pattern, especially how the volume has behaved during different price periods are close to what Mr. O'Niel suggests (higher green volume bars, rising volume into right side, falling volume during the handle, high volume at capitulation low and breakout days etc.)

One aspect which I disagree with you quite strongly with you is your claim of a V shaped bottom. I see no V here; I do potentially see a W on the right side of the cup. I also would reiterate the fact that in a market with extreme moves like this, some of the basing action is bound to be more spiky and choppy than more normal times . However the handle over the past few weeks has been much better behaved, reflecting a gradual stabilization the market, which is also being reflected by the VIX.

This a period where disciplined traders can make money and BAC is one of the stocks with the potential to do so, as long as you are careful about when and where you enter the position and when you take your losses.

Apr 12 10:23 PM

[prudentinve...:]

My guess is that the shares of BAC, as well as of all large US banks, will eventually recover; perhaps not to the dizzying heights of 2007 for several years, but to well above current levels.

The risk/reward paradigm of the new and improved capitalism is that the banking system's risk is to be borne by taxpayers, whilst the rewards are to go mostly to the banks. This ensures that banks cannot lose, but can only profit. I strongly disapprove of this distortion of free markets, but it now appears to be reality, especially as details of PPIP emerge; so I have long positions in several major US banks which I would have avoided in a traditional, capitalist free-market environment.

Apr 13 07:44 AM

[slipperyrazor:]

bank of america needs to start treating the american consumer much bettter. its image is probably permanently flawed. if their is a way to take advantage of. the consumer they will find it. as a tarp recepient, it is beyond me why the government allows them to conduct business in this manner

Apr 13 08:33 AM

[buoy:]

Customers are fed up with BAC.

Apr 13 09:17 AM

[Darvania:]

Vikram Saxena,

Thanks for the reply and my apologies if I came across harshly. Because we're in a vicious primary bear market (despite the current little rally) that does not mean we throw out the rules on what makes a proper cup/handle pattern. As for you not seeing a "V'ish" shaped bottom to the cup it's because you have the strangest looking stretched out chart scale I've ever seen anyone use. Every pro technical chartist and trader I've known and studied under for over a dozen years uses as the standard chart a daily on a 6 month to one year period, with LOGARITHMIC scaling. Use that for BAC and the V shaped bottom jumps out at you, especially starting with the low on 3/6 and the move from there to 3/19. BTW, I'm long BAC as I bought the breakout early Friday as price broke through top/resistance of the two week pennant. Cheers.
On Apr 12 10:23 PM Vikram Saxena wrote:

> Darvania:
>
> The market has thrown out all rules during the past year. Further
> the scope of the market decline has matched some of the worst bear
> markets in history. As a result the ratios which may have worked
> well in the past can not be applied religiously here since the market
> is not behaving in a manner when those rules were developed and refined.
>
>
> As I noted in my article, even if we accommodate for stretched ratios,
> the pattern is not perfect and has to be traded with a lot of caution.
> However, there is no denying that the 1st order metrics of the pattern,
> especially how the volume has behaved during different price periods
> are close to what Mr. O'Niel suggests (higher green volume bars,
> rising volume into right side, falling volume during the handle,
> high volume at capitulation low and breakout days etc.)
>
> One aspect which I disagree with you quite strongly with you is your
> claim of a V shaped bottom. I see no V here; I do potentially see
> a W on the right side of the cup. I also would reiterate the fact
> that in a market with extreme moves like this, some of the basing
> action is bound to be more spiky and choppy than more normal times
> . However the handle over the past few weeks has been much better
> behaved, reflecting a gradual stabilization the market, which is
> also being reflected by the VIX.
>
> This a period where disciplined traders can make money and BAC is
> one of the stocks with the potential to do so, as long as you are
> careful about when and where you enter the position and when you
> take your losses.

Apr 13 02:04 PM

[mr clark:]

when people start talking about insolvent companies being poised to break upward... the stock market has finally crossed the threshold to fantasy land...

Apr 13 02:23 PM

[Drew Arnold:]

Good technical analysis. Keep in mind, however, that the bank stocks are still subject to MAJOR influence from government actions, which I think decrease the value of technical analysis a little bit. Also, after Wells Fargo's guidance, there seems to be a lot of speculation over what the banks are actually earning right now. Look for earnings season to be especially volatile for the banks as investors find out what they're actually bringing in.

Apr 13 03:07 PM

[anarchist:]

Customers have ALWAYS been fed up with Bank of America and it's lack of regard to their banking needs and being stuck with ridiculous charges-but ya know what? B of A is still out there and it appears that, thanks to their customer's (and a "few" non-customers) tax dollars, they will be around for a long time. Take a look at this, it will make you sick-but where is the outrage?
www.pbs.org/moyers/jou...


On Apr 13 09:17 AM buoy wrote:

> Customers are fed up with BAC.

Apr 13 03:39 PM

[dok tari:]

Silly article. The destiny of BAC is being determined in the mortage market not washington. With alot of competition wiped out (good by WAMU) and influx of capital to lend, crashing of house prices and recent increases in house sales BAC will become a money factory once again. The market is speaking not your silly charts.

Apr 13 03:53 PM

[Schweizer:]

The massive selloff starts Tuesday.

Apr 13 04:50 PM

[Vikram Saxena:]

Darvania:

I was intrigued by your comments so tried out a log scale. This following link shows how that looks on a 6 month and a zoomed in version (3 month).
screencast.com/t/0qxxa...

To me even the log graph clearly shows a W shaped double bottom on the right side of the cup. I have marked it with yellow lines. It is a stronger pattern since the second low was higher than the first low. In fact the log chart tends to de-emphasize the steep fall which would have worked against the pattern.

If you just consider the closing prices (third graph) we can see a V shaped. However this closing low was well (23%) above the intra-day low reached on the capitulation day which had much higher volume. Further the closing prices ignore the true range of the stock especially if the swings are made on high volume. Sure the base is very spiky but we are trading in very volatile times.

Trade smart and enjoy your gains.

Apr 13 05:40 PM

[Darvania:]

Thanks for link to the graph where you use the log scale. I see the W bottom that you refer to now...reason I didn't see it or call it earlier is because it fails the classic test, i.e. right side's low undercutting the lows of left side of W to rinse out remaining weak hands. At least that's how I interpret the double or W bottom, I'm not saying my was is THE way:) The V'ish shape to bottom of the cup I should have been more specific....I was looking at the V shape starting at the high on date 2/26 (top of W), then the drop to lows of 3/6, then rapid climb to 3/19. But that's getting off the main gist of what I was really getting at..... the main point I wanted to make about the faulty cup bottom is the loose and sloppy price action of the bottom, i.e. NOT rounded and without tightening of the daily trading ranges. Back to the charts with your link, those (for me anyway) are much better than your first one top of this page. The standard way to present a chart for the study of patterns is with a 2 to 1 ratio, i.e. horizontal width being approximately 2x the vertical height, or a 2:1 rectangle. The reason as that for better or worse down through decades authors of tech analysis who have published widespread books with graphics of chart patterns gradually started using that 2:1 ratio, so it became the unofficial default ratio. It's good that is evolved that way because everyone nowadays is more or less on the same page so that when different traders pull up their charts they're more than likely to see the same pattern. Enjoy the exchange and give and take with you Vikram. Cheers.

Apr 13 06:14 PM

[Alex S. Gabor:]

"Short a billion shares of BAC a day till it trades at a penny, then bend over and cover your assets", so sayeth "The Penny King".....

www.associatedcontent....

Apr 13 09:22 PM

[mwfall:]

ever dream of reading a completely useless article?
you just got your wish.

Apr 14 01:59 AM

[MIKETRADER:]

For directional investors I don’t think you’re getting a good value investing in Bank commons, especially Citi or BAC, if you see the prices of the junior and senior subordinated debt of some of the major banks its implying, that at least actual prices of the commons are high, and at worst that common shareholders are going to be heavily diluted if not all... if you want to get in the action in banks I recommend look at ETRUPS, TRUPS, Subordinated Debt some examples:

1) CITI 5% subordinated notes due 2014 @ 67
2) BAC TRUPS - PRB, PRC & PRX all yielding above 13% and 50% discount FV.
3) JPM, all preferred have nice yield and 10 to 20% capital appreciation in the following months should be expected....

You can get big returns north of 30% on this, without the risk of lossing 50% or more on your position.....

… and for those who want to get into the "arbitrage play" and make big bucks, I recommend you to take a look at Wells un-cumulative preferred such as WFCPRL that’s its trading a 50% discount of its face value while WFC is trading at 3 to 4 times its TCE per share.... obviously there’s a big disconnect between on what the commons and the preferred are pricing.

Buy WFCPRL, and buy OTM July PUTS of WFC... that way you will gain big time, when this mispricing corrects and you don’t get shortsquizzed by shorting directly de common.

Apr 14 06:02 PM

[Oleg M:]

Yes! if you move backwards in time.

Apr 14 06:46 PM

[Analysis50:]

Hi Vikram,

Nice article. I checked out a few of the perpetual preferreds that BAC has outstanding and see that they are currently trading at apprx. 50% of $25 face value. That is a huge discount, which doesn't make sense since I don't believe there's much doubt now about BAC's survivability. Any thoughts on your part? I would appreciate it.

Thanks.

Apr 16 09:44 PM

[MIKETRADER:]

The perpetual & non.cum preferreds, are discounting a forced conversion into common equity, which may or not happen, from what I been reading from bank analyst they see a range from 10% the more optimistic to 40% the more pessimistic dilution on common equity at BAC, IMO I think the dilution will come north of 10% which maybe is done through a stock offering and not a conversion (given what has happened recently with HSBC).

By the way I see more dilution if it were to come on a TCE/RWA @ 3% for WFC that for BAC, I see a 20% dilution, but will see....

About Tier 2 capital I think is way to low, I don’t think government will force a haircut on Junior or Senior Subordinated debt, because of 2 reasons: 1) The government knows the serious loss implication that I will have on this bondholders, Insurers, Pensions, foreign gov., etc....; 2) Full or parcial conversion of Tier 2 Capital into Common will as stated by someone else ... “The current prices (Subordinated Debt) imply that the companies’ equity is worthless, the government’s investment is worthless and subordinated debt holders will lose some of their investment".

Apr 17 02:43 PM

[Freya:]

All Bull markets climb a wall of worry and the public gets in near or at the Top.

Hedge and Mutual Funds "Had to sell" due to redemptions not because of Fundamental Value.

With an estimated $8 Tillion in purchasing power on the sidelines, buy the ones that got away before.

Apr 13 03:35 PM

[Freya:]

Well, if the "cup with handle" criteria is flawed in the case of BAC, how about the H&S bottom on the XLF which just had a Breakout.

Sure sounds like a case of a short biting the bullet.

Apr 13 01:37 AM