Many years ago, I had time to kill waiting for a flight in Denver. I called a friend who said he was nearby and could be there in a few minutes.

He’d been teaching me about the markets and I was looking forward to another lesson.

As he sat down, he handed me a copy of Investor’s Business Daily and began explaining why I should be familiar with it.

We spent the next couple of hours looking at how the newspaper applied relative strength and fundamentals.

There was a complete trading method in those pages, and at a single meeting in an airport, I was able to understand all of it.

As we wrapped up our meeting, I knew how it would end. He would assign me homework as he always did. This time, the assignment was to read “The Battle for Investment Survival” by Gerald Loeb.

My friend explained that he had seen William O’Neil, the founder of Investor’s Business Daily, speak several times. O’Neil always mentioned that he had read hundreds of books on the stock market and there were only two that he believed every investor should read: First, of course, was O’Neil’s book, “How to Make Money in Stocks.” The second was Loeb’s book, which was written in 1935.

Both books are quick reads and complement each other. They both advise buying stocks that are going up and cutting losses quickly. Of the two, I think Loeb’s book provides a better understanding of the philosophy of trading, while O’Neil provides more information about the mechanics of selecting good stocks.

In his book, O’Neil says that it’s better to buy stocks that are going up, a strategy that can make many investors uncomfortable. Individuals often focus on value and look for bargains in the market. They might look at a stock trading near its 52-week low and assume that means the stock is on sale. And it might be… but it also might be in a strong downtrend and on the verge of dropping more.

O’Neil explained that we should think about how a stock reached a new 52-week high. He wrote, “As a final appeal to your trusty common sense and judgment, it should be stated that if a security has traded between $40 and $50 a share over many months and is now selling at $50 and is going to double in price, it positively must first go through $51, $52, $53, $54, $55, and the like, before it can reach $100.”

In other words, if a stock is going up, it has definitely been setting new 52-week highs along the way. Because the trend is up — and there are likely more 52-week highs in the stock’s future — the best choice could be to buy it on a pullback.

Spotting This Trend In Real Life

O’Neil cited a pattern to identify the ideal buy candidate that he called a “cup with handle” pattern. There are precise rules for this charting pattern, but the most important pieces are (1) a pullback (2) followed by a consolidation, like the ones highlighted below in the chart of AbbVie (NYSE: ABBV).

The cup portion of the pattern is highlighted in blue. This is the pullback. ABBV sold off about 13% from its 52-week high, but buyers emerged and prevented the stock from falling too much.

After the stock recovered its losses, resistance developed near the old highs. This is common. Resistance likely formed when short-term traders took profits in ABBV. They may have bought near the lows and were happy with an 8% gain in less than two weeks.

But, the selling pressure was less intense and the decline was relatively shallow. This is the price consolidation, or the handle of the cup, which I’ve highlighted in green.

Based solely on the chart pattern, we could say ABBV is a “buy.” But digging deeper, I’m still bullish on the stock for other reasons.

This Long-Time Favorite Still Has Room To Run

I’ve written about AbbVie a few times before. It is one of the world’s largest drug makers (the seventh-largest by market cap), known to many for its best-selling drug, Humira, a biologic therapy for autoimmune diseases including rheumatoid arthritis, Crohn’s disease and other inflammatory conditions. This is the best-selling drug in the world, with sales of more than $15 billion a year.

Other blockbusters include the blood cancer drug Imbruvica, which is now the first-line treatment for many variations of the disease. Another treatment for leukemia, Venclexta, is expected to bring in more than $1.5 billion by the end of the decade.

The company also offers Viekira Pak for the treatment of hepatitis C, but it has not had much success in that market, which is largely controlled by Gilead Sciences (NASDAQ: GILD). AbbVie is working to develop other drugs before sales of Humira start to decline (expected next year). But the impending loss of patent protection for that drug is affecting the company.

The stock is trading at a below average price-to-sales (P/S) ratio and a below average PEG ratio, which is a metric that compares the price-to-earnings (P/E) ratio to the growth rate of earnings. This ratio recognizes that companies growing rapidly should trade at higher multiples than those with slow growth.

One surprise in the pipeline or an acquisition by AbbVie could significantly affect the company’s earnings and push the stock up sharply. Downside risks appear to be limited by the company’s below-average valuation.

While I am optimistic about the long term, I am most bullish about the short term, which is where I’ve identified a high-income opportunity in the stock.

How You Can Win Almost Every Time

What many investors don’t know is that this expected price move also sets up a high-probability, high-income opportunity in AbbVie using short-term options. Rather than buying the stock and hoping for the best, this surprisingly simple options trade allows us to take a greater gain in a shorter time.

The strategy I’m using for this trade, selling put options, is the same one my Income Trader readers and I have been using to make thousands of dollars in extra income each month. In this case, a rise in the price of ABBV would earn you a 2.5% return in just days, which equates to an exceptional 60% annualized return.

And what happens in case of a drop in price could be even better. If ABBV is trading under the expected price when your options expire in 15 days, you get to essentially buy the stock at an even greater discount (a full 6.0% less), leaving you with a solid stock at a price you could never get by waiting for price drops.

— Amber Hestla

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Source: Street Authority