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Don’t Short These Oil Stocks

May 02, 2011 11:30 AM ETLNG, CRK1 Comment
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Tom Aspray, professional trader and analyst was originally trained as a biochemist but began using his computer expertise to analyze the financial markets in the early 1980s. Mr. Aspray has written widely on technical analysis and has given over 60 presentations around the world. Many of the technical indicators that Mr. Aspray wrote about in the 1980s, such as the MACD, have since gained worldwide acceptance. Tom is regular contributor to Forbes where he writes a regular Week Ahead column.  His expertise as a technical analyst has been acknowledged by the WSJ as well as some of the best known technical analysts.

Bullish chart patterns and the potential for upside earnings surprises this week mean that investors should be looking to play the long side on these four energy stocks.

This is a big week for oil company earnings and there are four companies I think should be bought—not sold—and most announce earnings on Monday, May 2. As part of my analysis, I keep a close eye on the short interest data, as it often can help uncover good trading or investing ideas.

A couple months ago, in “Four Stocks You Shouldn’t Short,” I took a look at four stocks that had reported an increase in the number of shares sold short and also showed positive chart patterns. With the recent strong stock market, it is no surprise that all of these stocks now show nice gains.

In utilizing the short interest data, one can look for a large percentage increase in the number of shares sold short, or the short interest ratio, which tells the number of trading days that would be needed to cover the short position.

Sometimes these numbers reach astounding levels, and the most recent data, as of April 27, lists several stocks with a short interest ratio of over 50. That means using the stock’s average volume, it would take 50 days of normal-volume trading to cover the positions.

Over the years, I have found that even a short interest ratio as low as 5, when combined with a positive technical pattern, can set up a good trading opportunity.

Click to Enlarge

Chart Analysis: Goodrich Petroleum Corp. (GDP) is an $800 million independent oil and gas company that operates in Texas and Louisiana. Over 23% of the floating shares of this stock have been sold short with a short interest ratio of 7.5.

  • The weekly chart shows that the downtrend going back to early 2009 (line a) was decisively overcome in mid-March
  • Once above the recent highs at $23.80, the next strong resistance is in the $26.60 area, where GDP peaked in early 2010. Longer-term resistance is at $30.90
  • The weekly on-balance volume (OBV) broke through its corresponding downtrend late last year (line c), so this stock is being accumulated for some time
  • The daily OBV is locked in a recent range with initial chart support at $21.20- $22.00. A break below the support at $20 would suggest that GDP is vulnerable to a drop to the $18.50 area

Comstock Resources Inc. (CRK) is also a Texas-based independent oil and gas company that is about twice the size of GDP. It has a current short interest ratio of 9.7. CRK closed strong on Friday and is set to release earning after the close on Monday, May 2.

  • CRK broke through its steep weekly downtrend (line e) in January and has just closed above the recent high at $31.98
  • The next weekly resistance is in the $34-$36 area with the long-term downtrend (line d) now at $41.60
  • The weekly OBV has turned up from its weighted moving average (WMA) but needs to move through its longer-term downtrend to give a major buy signal. The daily OBV (not shown) looks very strong
  • There is initial support now at $30.20-$30.70 with more important support at $27.70, which, if violated, would break the uptrend

Click to Enlarge

Cheniere Enery Inc. (LNG) is a $600 million, Texas-based operator of onshore liquefied natural gas (LNG) receiving terminals and natural gas pipelines in the US Gulf coast. It currently has as short interest ratio of 5.7 and has traded in a wide range so far in 2011.

  • Two weeks ago, LNG dropped down to test the strong weekly support below $7.50(line a) but has rebounded quickly, suggesting that was a strong area of value. The weekly uptrend is now a bit lower at $7.27
  • A strong move above the $10.06 level would suggest that a continuation pattern had been completed, and that would give upside targets in the $12.50-$13 area
  • The weekly OBV showed strong accumulation last summer and fall as it turned up sharply. It continues to act well with support now at line c
  • There is initial support for LNG at $8.20-$8.65 and then at $8

Chesapeake Energy (CHK) has been in the news lately for a chemical spill in Pennsylvania, and at a capitalization of $21 billion, it is a much different company than Cheniere Energy. Chesapeake will report its earnings after the close on Monday, May 2, and though there are almost 20 million shares sold short for CHK, the short interest ratio is under 2.0.

  • CHK does have a very positive-looking weekly chart, as it overcame major resistance early in the year (line d) at $30. Over the past two months, CHK has approached this breakout level, and the stock turned higher last week, suggesting that the uptrend has resumed
  • There is next resistance now at $37.37 with the major 50% retracement level at $42.20
  • The weekly OBV staged a major upside breakout in late 2010 as it overcame the resistance at line f. It has continued to act stronger than prices and has just turned up from its WMA
  • The daily OBV has already broken out to the upside
  • There is first good support in the $32.70-$33.20 area with more important support in the $31 area

What It Means: Last week was a good one for energy stocks, and this week is full of new earnings reports from top energy companies. As I mentioned last week, though the weekly and daily analysis is positive for the stock market, a more defensive strategy is advised for new and existing positions. As a result, these recommended entry levels may be too low, especially if the earnings are much better than expected. If these do not get filled, I will continue to monitor these stocks.

How to Profit: For Goodrich Petroleum (GDP), go 50% long at $21.84 and another 50% long at $21.36 with a stop at $19.88 (risk of approx. 8%). Cancel the order on a move above $23.80.

Only buy Comstock Resources (CRK) on a deeper pullback. Go 50% long at $30.64 and 50% long at $30.22 with a stop at $27.62 (risk of approx. 9.2%).

Go 50% long Cheniere Energy (LNG) at $8.88 and 50% long at $8.64 with a stop at $7.93 (risk of approx. 9.4%).

For Chesapeake Energy (CHK), go 50% long at $33.32 and 50% long at $32.94 with a stop at $30.94 (risk of approx. 6.6%).

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