Today, I would like to take a look at a typical trade setup that the average retail investor tends to shy away from but the professional trader salivates over. The company is called Cobalt International Energy (NYSE: CIE) and is focused on oil exploration and production.#-ad_banner-#

At the moment, the stock appears to be in a healthy correction cycle; however, it is at a critical juncture — the range between $20.50 and $21.50. If the stock drops below $20.50, this should stop out longs and, depending on velocity, turn this into a great short trade. On the other hand, a break above $24.70 would set up a great long trade.

Additionally, with a beta of 2 versus the S&P 500, should the stock break in the direction of the S&P 500, it could get an extra boost and really reward those on the right side of the market.

Now let’s dig a little deeper into the charts.

The stock went public in December 2009, so the data on the charts are somewhat limited. Nevertheless, there is plenty of information to read out of the current setup to make it an attractive risk/reward play.

Narrowing Trading Range Supports a Breakout
For the majority of 2012 thus far, Cobalt has been forming a narrowing trading range, which on the chart is displayed through a nine-month-old triangle formation. By definition, a narrowing trading range should eventually give way to a move in either direction, which at its essence is what I am looking for in this setup.

Moving Averages — Bearish
Moving averages are, at best, only as good an indicator as any given security has respected them in the past. In the case of Cobalt, in its brief two-and-a-half years of trading history, each time the 50-day simple moving average (SMA) has crossed (either to the upside or downside) the 200-day SMA, it has led to sizable moves in the said direction of the stock price.

Around mid-September, the 50-day SMA crossed the 200-day SMA to the downside, and while I am not a huge fan of this particular signal, given the critical juncture the stock is trading at and the historical movements in this stock after such a moving average cross, it is a signal worth watching in this case.

Fibonacci Support Levels — Bullish
Something for the bullish case can be found in the Fibonacci support levels. Looking at the December 2011 to February 2012 rally in the stock, we note that the Fibonacci support zone still holds — between the 50% and 61.8% retracement levels of the move. In price terms, this support zone spans from $19.20 to about $22.50.

Momentum Oscillators — Mixed
A more mixed picture can be found when looking at some momentum oscillators such as the Relative Strength Index (RSI) and the slow stochastic indicator. The RSI is in a fairly neutral zone while the slower moving stochastic indicator is pottering around the oversold zone. Mathematically speaking, given the narrowing trading range in the stock as of late, this makes sense, and it means we have to focus that much more on the pure price action, because it is the ultimate arbiter.

Options Activity — Bullish
Cobalt averages around 1.7 million shares traded on a daily basis; however its options are less liquid.

Nevertheless, on Oct. 2, the Cobalt Nov 27.50 Calls (currently about 30% out of the money) were traded 1,000 times, indicating someone is making a decent size bet for the stock to trade to the upside before November options expiration.

In summary, both a bullish and a bearish case can currently be made in Cobalt. However, the beauty of this trading setup is the well-defined trading range, which if broken to the downside, sets up a good short-side trade, and if broken to the upside, is attractive for longs.

Action to Take –> Buy Cobalt above $24.70 or short Cobalt below $20.50. Set stop-loss at $23 (longs) or $21.50 (shorts). Set initial price target at $34 for a potential 38% gain (longs) or $16.50 for a potential 20% gain (shorts).

This article originally appeared on TradingAuthority.com:

Chart Signaling Breakout Ahead That Could Make Traders 20% to 40%