How to Play a Gamestop Breakout Rally

Shares of the video game and accessories retailer GameStop (GME) are forming a basing pattern just below their 200 day moving average. Bullish technical divergences suggest a breakout is imminent and the large outstanding short interest could spark a covering rally that has the potential to realize an 18% gain.

The weekly chart shows the stock attempting to recover from the sharp drop in late 2015, which saw it lose nearly half its value. A failed attempt to recover the 40 week moving average last year resulted in new lows, but the $20.00 level has held and the average is being retested. The price action over the last six months formed a cup and handle pattern with rim line resistance in the $26.50 area. Moving average convergence/divergence has been in bullish divergence to the declining stock price and the relative strength index is moving higher and above its centerline. These are indications of improving momentum and trend direction. Overall volume has been weak but Chaikin money flow crossed above its 21 period average and is tracking higher.

On the daily timeframe, the reversal pattern and the rim line retest can be seen in more detail. Earlier this month the stock moved over its 50 day moving average and continued back up to the current intersection of the 200 day average and pattern resistance. A bullish hammer candle formed in Monday's session closing above the average and on the pattern rim line. Daily moving average convergence/divergence is above its center line and the vortex indicator, which is designed to identify early shifts in trend, made a bullish green-over-red red crossover lat month. The accumulation/distribution line has crossed over its signal line and Chaikin money flow is above its center line, both suggesting the stock is experiencing renewed buying interest.

Gamestop is a long candidate after an upper candle close above cup and handle resistance using a trailing percentage stop. The pattern price objective is measured by adding the height of the cup to the rim line and targets an 18% gain in the area of the 2016 high.

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