An Undervalued Energy Stock Investors Can’t Ignore

I have said many times before, here and elsewhere, that technical analysis has its limitations. The idea that we can look at what happened in the past and confidently predict the future based on it appeals to some basic desire for order in the human psyche, but in many cases, it doesn't stand up to logical analysis. The circumstances at different times are inevitably different themselves, and just because "A" happened at some point in the past doesn't mean that "B" will follow. However, simple analysis based on previous highs and lows does have value.

When a stock bounces off a level, it is likely to do so again, even in different market conditions. It results in a perception that the level has its own significance, significance that will still be there in the future regardless of anything else. There is often some truth to that. A stock that is falling will often stop because many people perceive value at the same level and place orders to buy, and those buyers will probably re-emerge at that same level in the future. In addition, even if the low was prompted more by a change in fundamental conditions, when it is approached again it will attract buyers simply because it held before. They don't always prevail, but when they do and the level holds again, the perception of its significance increases.

That "double bottom" formation can be seen now in an energy stock that has disappointed a lot over the last year…Schlumberger (SLB).

An understanding of your own fallibility is essential to traders. Good account management is impossible if you believe you can never be wrong, so I will freely admit that during the last year, I have twice attempted to pick a bottom for SLB, with only mixed results at best. The first was on the way down at the end of the year, and came too soon, while the second, in February, came just before enough of a bounce to give a small profit, but the stock didn't reach the hoped-for highs.

Both of those calls, however, were based purely on an analysis of fundamental factors, such as the price of oil and the anticipated capital expenditure (capex) of oil companies. They had no technical support. In the first instance, my belief in a bounce in crude was right, but premature, while in the second the timing was better, but after the improvement in fundamental conditions came it faded quicker than expected. Now, with SLB forming a double bottom at around 34.50 and consolidating from there, it is worth another try.

The fundamentals for SLB still look good. Crude has bounced strongly off a previously established level around $50 and, barring a complete collapse for some unforeseen reason, that makes it likely that we have seen the worst of the cuts in capex. With that in mind, the emergence of a clear, repeated low and a clear bounce from that low sets up a trade with a good risk/reward profile.

Buying here with a stop just below that low and an initial target close to the April high of over $48 sets you up to make nearly twice what you are risking on the trade. That in itself is a good setup, but with a stock as depressed as this there is always a chance that if we get above $48, momentum will carry it through that level. The target, in this case, is a point at which I would reset the stop-loss rather than just cut and run, allowing the potential for an even better result.

At some point, the cyclical nature of the oil business and basic common sense indicate that Schlumberger will bounce. That could come soon, or it might not, but the double bottom pattern which is now clearly formed makes it more likely than not and allows for a logical stop level that limits potential losses. Those are good enough reasons to take another stab at the stock.