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A 7:1 Risk-Reward Trade In The Most Hated Asset
The market gave us a huge opportunity.
We have a better trade setup than the one we put on Texas Pacific Land Trust (TPL) — where we booked a 36% gain in 4 months.
Our risk-reward is anywhere between 7:1 - 30:1.
And it’s for (arguably) the most hated asset on the planet — coal.
Coal is still one of the cheapest forms of energy. It makes up 11% of US energy consumption.
Europe (specifically Germany) is turning to coal as they adapt away from Russia’s oil and natural gas. Germany now uses coal for nearly 1/3 of its energy consumption as a result of the Russia-Ukraine war.
We see a natural demand floor for coal because winter is coming.
The trade we initiated September 19th was on Peabody Energy (BTU).
Peabody engages in coal mining within the United States, Japan, Taiwan, Australia, India, Indonesia, China, Vietnam, South Korea, and elsewhere internationally.
Take a look at BTU’s stock chart over the past year.
You can see BTU has bounced off its 200-day moving average (the red line) almost perfectly the past 5 times.
This shows coal bulls have stepped in every time BTU has sold off. That’s an incredibly bullish sign.
The previous 4 times it bounced off the 200 DMA, it rallied an average of 137%. (100% / 350% / 66% / 33%).
We also looked at its relative strength index (RSI) and moving average convergence divergence (MACD) for confirmation.
The RSI simply shows whether something is overbought or oversold. An RSI reading of 20 means it’s very oversold. An RSI reading of 80 means it’s very overbought.
The MACD is a momentum indicator that shows the relationship to its exponential moving averages. Simply — it helps us understand how the stock’s been trading recently and whether there’s momentum building up.
When the MACD turns up — the black line crosses above the red line — there’s strong momentum building up in the stock.
The best time to enter these trades were when BTU was oversold and when the MACD turned up.
We can zoom in a little closer — looking at BTU over the past 6 months — and see the RSI was in the 30s-40s mid-late September and the MACD was starting to make a move higher.
Mike and I entered the trade at $19.91 on September 19th.
Our stop loss is set at $19 — which was its previous low set back in early August.
That gives us 4.5% downside.
So if BTU rallies 33% like it did the last time this setup happened… then our risk reward is 7:1. A 33% rise from our cost basis puts the stock at $26.50. (We wrote this on Thursday, September 29th. We’re already just 6.6% away from our first price target.)
However, if it rallies 137% — the average of the previous 4 times we had this trade setup — then our risk reward jumps to 30:1.
Our strategy is to continue to lean into BTU until it reaches overbought territory. Then take some profits.
This isn’t a trade Mike and I want to be in for the long term. The previous setups would mean we’re in it for 1-4 months max.
The technicals show BTU has plenty of upside left. But the risk-reward isn’t as compelling anymore. So I wouldn’t put the trade on today. But we’re confident we’ll get another opportunity in this name.
Be patient.
It’s happened 5x in the past 12 months. We’re sure there will be a 6th.
Good investing,
Lance