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Shares of Cheesecake Factory (CAKE) are undergoing a "volatility squeeze," or a period of acute consolidation that often precedes a sharp move in the stock price. It has the potential to be an explosive trading setup that can produce powerful profits.

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One way that technicians identify a potential volatility squeeze is when the Bollinger bands, a measure of standard deviation around an average price, move inside the Keltner Channel, a measure of standard deviation around average true range. This setup has developed two times in the last year, first in April and then again in October, and in both instances, it was followed by a volatile move in the stock. Price compression, or low volatility within clearly defined support and resistance, was followed by rapid expansion and an increase in volatility.

Currently, the Bollinger Bands are well within the Keltner Channel, and price has been contracting inside a narrowing range between $48 resistance and $44 support. During this consolidation phase, the relative strength index has been in bullish divergence and has moved above its 21-period average and centerline. Daily moving average convergence/divergence is overlaid on a weekly histogram of the oscillator and is making a bullish crossover on both timeframes.

The direction of these short-term momentum and trend indications suggest that the volatility squeeze will be followed by a break above resistance and the move will be higher. The money flow indicators are in agreement, with the accumulation/distribution line above its signal average, and the money flow index, a volume-weighted money flow measure, tracking above its 21-period average.

The stock is a long candidate after an upper candle close above the declining resistance line, currently at $47.75, using a trailing percentage stop.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.