Vikram Saxena's  Instablog

 The stock price of Bank of America made an impressive move today 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 that 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