Alibaba Group Holdings Inc.: 250%+ Upside Potential on BABA Stock?
BABA Stock: The Bull is Back
Alibaba Group Holding Inc. (NYSE:BABA) stock had a successful initial public offering (IPO). Shares closed at $93.89 on its first day of trading and, two months later, shares hit a high of $119.07, representing a return of 26.8%. That’s an impressive return given the short time horizon, but unfortunately that impressive start was just a head fake. BABA stock proceeded to fall from a high of $119.07 to a low of $57.20 over the next 10 months. This represented a painful loss of 52%.
I have been watching BABA stock for some time now, waiting on trading signals. One signal was already confirming a bullish bias, and if you have read any of my previous articles, you would already know that one signal on its own is not sufficient to initiate a position. I prefer multiple signals to confirm the trend. As I’m writing this, BABA stock has just breached a technical level of resistance that confirms a bullish objective and gives me the necessary objective signals to pursue a trading strategy.
I will start by outlining the signal that first identified a bullish bias. The following chart illustrates a “golden cross”.
Chart courtesy of StockCharts.com
On February 8, 2012, BABA stock generated a golden cross. A golden cross is a bullish signal that is produced when a 50-day moving average, highlighted in blue, crosses above a 200-day moving average, highlighted in red. Traders use this signal to confirm that a bull market is on the horizon. It is always wise to trade in the direction of this signal. A neutral or long position is warranted; there is little reason to hold a short position after this signal is generated.
The following chart illustrates a technical pattern setup.
Chart courtesy of StockCharts.com
On August 10, 2016, BABA stock confirmed a “double bottom”. A double bottom is a reversal pattern that appears at the end of trend. It is marked by two consecutive bottoms, separated by a peak in between. The pattern is confirmed when shares close above the peak that separates the two bottoms.
Double bottom patterns are also of great benefit because not only do they signal a change in trend, but they also produce a possible price objective. This reversal pattern projects a potential price target of $110.00.
I now have the required information to set up a potential trading strategy: two confirming signals and a price objective.
I like to employ options to illustrate potential strategies. Options have the benefit of lowering the initial outlay, and the risk is defined by the initial outlay.
A “bull call spread” would effectively capture my objective. This strategy involves simultaneously buying calls at one price and selling an equal amount of calls at a higher price that expire on the same day.
For example:
- Buying January 17, 2016 $95.00 call for $4.95
- Selling January 17, 2016 $110.00 call for $0.99
This is a net outlay at $3.96 per share, and this also represents the maximum loss.
At expiry, if BABA stock is trading above $110.00, the value of this strategy will equal $15.00. This would represent a gain of 278% less any applicable fees.
The option strategy involves risking $3.96 to make a potential return of $15.00. It is also worthy to note that this sample strategy hits break-even when BABA stock trades above $98.96.
The Bottom Line on Alibaba Stock
BABA stock has just generated the required signal to confirm a bullish trend reversal. The confirmation provides us with the information needed to generate a trading strategy. As long as BABA stock stays above the peak that defined the double bottom, the trading bias will remain to the upside. Only a break below that level will be a cause for concern, and would require closing the position.
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