A Small-Cap Energy Stock Fueling Up to Break Out

DELAFIELD, Wis. (Stockpickr) -- Breakout trading is a trading strategy that involves taking a position in a stock during the early stages of a possible new uptrend. If your timing is right, you can find yourself ahead of the crowd as the stock begins its course for higher prices.

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I scan the markets every day for potential breakout candidates that look to be setting up to take out key defined resistance levels. I look for stocks that are coming off clear support levels and that are starting to spike higher with unusual volume flows. That unusual volume can be a sign that smart money is moving into the stock and getting ready to take out the sellers that are in control at clear resistance points. Once a stock takes out those clear resistance levels, then it is free to embark on a new price discovery journey.

Once a stock enters breakout territory, you usually see an increase in volatility as the control for that stock moves from the bears to the bulls. Bears like to be sellers at resistance, so once they lose control it can be a clear message from the market that the bulls are in the driver's seat and the stock is ready for a major price trend. That being said, breakouts are not a guarantee and many times you will see a stock start to break out and then fail. That's what we call a "fake out" in the trading community.

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One sector that's been in play recently for breakout traders is energy. This sector has been red hot as geopolitical tensions continue to mount in Ukraine and in other hot spots around the word such as Syria. While the market has been slaughtering momentum stocks and high-multiple stocks, the energy stocks have been seeing money flow. Energy stocks generally don't trade at sky-high multiples, and they're considered a great hedge for geopolitical risks.

With that in mind, one under-$10 independent energy player that's setting up here for a breakout trade is Gastar Exploration (GST), which is engaged in the exploration, development and production of oil, condensate, natural gas and natural gas liquids in the U.S. This company has a market cap of $386 million and an enterprise value of $662 million. This stock trades at a very reasonable valuation, with a forward price-to-earnings of 9.9. Its estimated growth rate for this year is 52.6%, and for next year it's pegged at 117.2%.

Just recently, Wunderlich Securities started coverage on Gastar Exploration with a buy rating on a price target of $9 per share. Analyst Jason A. Wangler said: "The company has gone through a transformation with multiple acquisitions and divestitures but is now positioned with two strong, scalable core assets in the Appalachia and Mid-Continent regions. We like the company's growth prospects from its proven Marcellus and Hunton targets and see strong upside potential in the Utica, Woodford, and Meramec formations that could generate value."

Gastar Exploration reported earnings earlier this week for the first quarter of 2014, and it said adjusted net income was $1.4 million, or 2 cents per share. The company said adjusted EBITDA was $25.9 million, or an increase of 71% vs. the adjusted EBITDA of $15.1 million for the first quarter of 2013. Revenue from production soared by 154% to $38.8 million for the first quarter of 2014 vs. $15.3 million for the same quarter in 2013.

I think it's fair to say those are some decent growth numbers that Gastar Exploration is putting up, and now with earnings out of the way, it's time to take a strong look at the technical picture for this stock to see if it's preparing to trigger a technical breakout trade. I have found over time that some of the best breakouts that sustain for large price moves come with a stock that has an average to strong fundamental backdrop.

From a technical perspective, shares of Gastar Exploration have been trending sideways and consolidating for the last month, moving between $5.75 on the downside and $6.85 on the upside. Prior to this short-term consolidation, shares of GST have been trending range-bound on a longer-term timeframe as well, with the stock moving between its December low of $5.03 a share to its February high (which is also its 52-week high) of $7.13 a share.

Shares of GST have now started to spike higher back above its 50-day moving average of $6.10 a share with heavy upside volume. Volume on Thursday registered 2.38 million shares, which is well above its three-month average action of 1.05 million shares. Since that volume came as GST moved over its 50-day moving average, it's a fair to suspect that some large institutional traders are loading up on the stock here in anticipation of a major trend higher. Large institutions play close attention to a stock as it trend over a key moving average like the 50-day, so this could be telling us that there's a lot of demand for shares of GST here.

Traders should look for long-biased trades in GST if it manages to break out above some key near-term overhead resistance levels at $6.83 to $6.85 a share and then once it breaks clear of its 52-week high at $7.13 a share with high volume. Look for volume on that move that hits near or above its three-month average volume of 1.05 million shares. If that breakout materializes soon, then GST will set up to enter new 52-week-high territory, which is bullish technical price action. Some possible upside targets if GST takes out these levels with volume are $9 to $10 a share.

You can look to buy GST off weakness as long as it's trending above some key near-term support at $5.75 a share if you want to keep it tight, or you can target the uptrend line that sits right around its 200-day moving average of $5.15 a share. That uptrend is an important technical level, since it has held as support over the last six months. Drawing trend lines like that on a chart gives you a great guide to the overall direction of a stock and where longer-term support levels are located. Traders can also look to buy GST of strength once it clears those breakout levels with volume and then use a stop that sits a comfortable percentage point from your entry.

-- Written by Roberto Pedone in Delafield, Wis.


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At the time of publication, author had no positions in stocks mentioned. Roberto Pedone, based out of Delafield, Wis., is an independent trader who focuses on technical analysis for small- and large-cap stocks, options, futures, commodities and currencies. Roberto studied international business at the Milwaukee School of Engineering, and he spent a year overseas studying business in Lubeck, Germany. His work has appeared on financial outlets including CNBC.com and Forbes.com. You can follow Pedone on Twitter at www.twitter.com/zerosum24 or @zerosum24.

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