The Gilmo Report

April 16, 2017

April 16, 2017

The underlying weakness of the market became a little more evident on Thursday ahead of the long three-day Easter Holiday weekend. The S&P 500 Index made a lower closing high on slightly higher volume, adding to the string of distribution days it has logged since mid-March. In the process, it has moved further below its 50-day moving average, which now represents overhead resistance.

The slightly higher trading volume was interesting given that it occurred on the final trading day before a long holiday weekend. The expectation was that trade would slow down as traders left for the Hamptons, but those weekend getaway plans were apparently put on hold long enough to get some selling done.

 

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Meanwhile, on Thursday the NASDAQ Composite Index logged its first close below the 50-day moving average since December 2nd of last year. Volume came in slightly lighter, which would be expected ahead of the three-day holiday weekend. However, relative to volume levels over the past several days, this was not a significant volume dry-up.

 

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Objectively, the index action looks bearish, but the signs were already there per my report of last weekend. I might also add that, at least to my nose, a bad smell has been emanating from underneath the hood of the market for at least a little while.

Whether it is just an olfactory hallucination, as can often be the case in this Ugly Duckling environment, or indicative of something more ominous, depends on what individual stocks are doing. In many cases, if you are focusing on and watching your stocks, as you should be, you are watching them breach through nearby support levels. Over this past week the action in individual stocks added to the odor.

Consider also that even as Fed heads run around babbling about an improving economy, alleged “full employment,” and the need to stay on track with respect to several pending interest rate increases this year, bonds are rallying, precious metals are rallying, and the dollar has been trending lower since January.

And financials, which are billed as the primary beneficiaries of higher interest rates, are acting as if rates are headed lower. On Thursday, three big money center banks, Citigroup (C), Wells Fargo (WFC), and J.P. Morgan (JPM) all reported earnings and beat estimates.

While WFC, not shown, simply gapped down within an already pronounced downtrend and busted its 200-day moving average, both C and JPM pulled big outside reversals to the downside. After rallying earlier in the day after the “strong” earnings report, C reversed at its 50-day moving average on very heavy selling volume. This looks like a short here using the 50-day line as an upside stop, although an alert short-seller might have been able to pick it off at the 50-day line on Thursday. After all, C is a failed-breakout type of short-sale set-up.

 

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JPM also rallied after reporting “strong earnings” but reversed at its 20-day exponential moving average on huge selling volume. So, while all the market mavens and pundits are telling everyone that they absolutely must buy the financials on the recent pullback, the financials are having none of it and simply moving lower. The bottom line is that unless these big-stock financials find their feet soon and reverse these sell-offs, their real-time message is not constructive for the general market. And as they sold off on Thursday so did the general market.

For anyone alert to it, JPM was a short Thursday morning right at the 20-day exponential moving average. From there, the stock reversed hard on an outside reversal as sellers swarmed the stock. It is now undercutting the prior late March and early April lows as it breaks out to the downside. Like C, it is a failed-breakout type of short-sale set-up.

 

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I’ve discussed many times that successful short-selling requires a copious amount of resourcefulness, cunning, and sheer courage (RCSC). In my view, it is something primarily for experienced traders who have already spent some time dancing with the devil on the short side of the market.

Newcomers to short-selling should start with very small position sizes to gain practical experience without exposing themselves to serious harm. To help newbies (and experienced traders who have never shorted stocks before) gain an understanding of short-selling as I practice it, I explain my methods in the book Short-Selling with the O’Neil Disciples. You can also read How to Make Money Selling Stocks Short, which I co-authored with Bill O’Neil back in 2004, but I would say it is not necessary. The new book covers all the relevant material.

The example of Applied Optoelectronics (AAOI) illustrates this need for RCSC. On Thursday morning, I tweeted that the stock was gapping up over 25% in pre-open trade, and this was taking the stock right up toward the prior failed breakout point in the low 50’s. Therefore, this could turn out to be a late-stage failed-base short-sale entry opportunity.

The company had pre-released earnings that represented a reasonably strong beating of the proverbial estimates. It was no doubt intended to revive their comatose stock, which failed miserably on a breakout attempt from the base formation less than two weeks prior. AAOI had since blown to pieces, trading well below its 50-day moving average before this morning.

Part of my pre-open routine is to go through my watch lists and see if anything is gapping up or down on news, which is what alerted me to the pre-open gap. Right around the time the pre-market trading session began at 5:00 a.m. my time on the West Coast, AAOI had gapped up to and was trading around the 51 price level.

To an alert short-seller well-versed in the concept of RCSC and its application to short-selling, this action in AAOI would serve to perk up one’s short-selling antennae. Reviewing the chart, it was also possible to see that the move was taking the stock just above its 10-day and 20-day moving averages. Therefore, in addition to being an LSFB short-sale set-up, it had the potential to evolve further and form a right shoulder in a potential, nascent head and shoulders formation IF it ran into resistance at the moving averages.

 

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The five-minute “620” intraday chart was also revealing in that it would have helped to guide one’s short-sale entry trade at the bell. For newcomers to the report, I should note that the 620 chart is a tool/device I developed to aid in the timing of short-sales and short-covers that was not included in the book, Short-Selling with the O’Neil Disciples.

It is, however, discussed frequently in the report. and if one is interested in understanding its application in further detail, searching on the term in the report archives will bring up several reports wherein the concept is discussed. Anyway, back to AAOI’s 620 chart on Thursday morning.

We can see that just moments before the opening bell, a 620 sell signal was already in progress as the orange 6-period exponential moving average. crossed below the 20-period exponential moving average. The associated MACD lines had already crossed. Using this, one might have been able to initiate a short position somewhere above the 49 price level.

I always like to say that when shorting, you will find that its works best when it works the easiest. In other words, if you short something and it is stubborn, then perhaps it isn’t going to work. Usually, I find that the most successful short-sales feel the easiest, where the stock obediently and immediately heads lower.

That was the case with AAOI, and as it moved lower it flashed a “MACD Stretch & Cross” which can often indicate that the first intraday movement to the downside is losing velocity. But if one had gotten a short off around the 49 price level, that was a very profitable move. Later in the day, near 11:00 a.m. my time, another 620 sell signal emerged and the stock limped lower to close at 45.37, over 10% from its pre-open peak.

 

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For now, I would look at any weak rallies by AAOI up into its 20-dema at 48.01 as potentially more optimal short-sale entry opportunities.

Apple (AAPL) reversed at its 20-day exponential moving average on Thursday after initially breaching the line on Tuesday on heavy selling volume. Earnings are expected on May 2nd, and it would not surprise me to see profit-takers send the stock down on a test of the 50-day moving average ahead of earnings.

 

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Facebook (FB) is expected to report earnings the day after AAPL, and it is acting in a similar manner. It closed below the 20-dema for the first time in 2017 on Tuesday with selling volume picking up on the day. On Thursday, FB reversed at the 20-dema on light volume to close in the red, like AAPL. Watch for a test of the 50-day moving average ahead of earnings.

 

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One of the things I find most amusing about Tesla (TSLA), is its ability to make life miserable for shorts. This is one reason why I dubbed it my “Stock of the Year” in my January 2nd report. It was not so much a prediction of price movement, but a revelation that it would be an interesting name to watch and play in 2017. However, at that time we were seeing some nice bottom-fishing and roundabout pocket pivots in the pattern closer to 200, which fed my view that an upside move was brewing.

After breaching the $300 Century Mark on Wednesday, TSLA announced that it would be unveiling an electric Semi truck in September, followed by an electric pick-up truck in 18 to 24 months. That set off a buying spree in the stock, pushing it back above the 300 price level on a continuation pocket pivot move.

The stock did stall off the highs as the general market sold off later in the day, but for now the 10-day moving average serves as near-term support. Whether TSLA can move significantly higher through this latest Century Mark may simply be a function of its expected May 3rd earnings report.

 

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Among big-stock NASDAQ names, TSLA is a bit of an outlier currently, as other big-stock names drive the selling in the indexes. Amazon.com (AMZN) moved further below its $900 Century Mark on Thursday with volume picking up slightly.

It is now headed for a test of the 20-day exponential moving average, but treating this as a short on the breach of the $900 Century Mark per Livermore’s Century Mark Rule in Reverse would be working so far. The question is whether AMZN will hold the 20-dema, which is something to watch for. Keep in mind that a pullback to the 20-dema would not be abnormal if volume remains light, so a bounce off the line would not be surprising to see, in my view. Earnings are expected on April 27th.

 

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Netflix (NFLX) closed below its 50-day moving average for the first time in 2017 on Thursday, but selling volume was light. Currently the stock’s chart pattern strikes me as something of a possible late-stage failed-base (LSFB) shot-sale set-up in-the-making. We can see that over the past month NFLX has attempted to break out to all-time highs twice, and has failed both times. A third attempt was made on Wednesday, but the stock reversed at the 10-day moving average and reversed to close down, and on Thursday closed below the 50-day line.

NFLX is expected to report earnings on Monday after the close, so there is nothing to do here ahead of earnings. What will be interesting to see is whether the current LSFB-type set-up on the chart turns out to be a clue as to how NFLX shares respond to the earnings report.

 

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Alphabet (GOOGL) is perhaps the weakest of the biggest of the big-stock NASDAQ names (say that ten times fast!). After two big-volume breaks off the peak in late January and mid-March the stock is now living below its 50-day moving average. The stock has been shortable over the past few days on rallies up to the 50-day line and has reversed each time. However, earnings are expected on April 27th, so it’s not clear whether a big downside move from here will occur before then. The current price/volume action does, however, argue for a bearish resolution after earnings.

 

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Priceline Group (PCLN) breached its 20-day exponential moving average on Wednesday, closing below the line for the first time in 2017 on above-average volume. Note that this breach of the 20-dema seems to be a theme for most of these leading big-stock NASDAQ names that have helped drive the “Trump Rally” so far in 2017.

I wrote on Wednesday that, “This could put the stock in a shortable position using the 20-dema as a guide for a tight upside stop.” PCLN moved lower on Thursday as volume came in slightly above-average and looks like it is setting up for a test of its 50-day moving average.

 

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Nvidia (NVDA) is starting to under the late February and early March lows in its pattern as selling volume picks up but remained well below-average on Thursday. I would watch for an undercut of these lows as a near-term cover point, and wait to see whether a shortable undercut & rally move materializes.

A nice undercut & rally move back up toward the rapidly descending 10-day and 20-day moving averages might set up a more optimal short-sale entry opportunity. If one is exceptionally nimble, one might even consider trying to play any undercut & rally move for a quick upside scalp. NVDA isn’t expected to report earnings until May 9th, so a lot can happen between now and then. I consider the stock a primary short-sale target in this market, but currently we need to see a rally that would set up a more optimal short-sale entry point.

 

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Netease (NTES) reached what I would consider a near-term cover point after becoming quite shortable at the 50-day moving average on Tuesday of this past week. On Thursday, the stock filled the prior “rising window” upside gap move and attempted to bounce on weak volume.

This would appear to set up a possible reaction bounce from here. Thus, I would watch for any weak rally back up toward the descending 10-day and 20-day moving averages that might offer more optimal short-sale entry or re-entry points. NTES isn’t expected to report earnings until May 10th.

 

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While NTES looks like it could bounce from here, Weibo (WB) might be in a more appropriate short-sale entry position. After a brutal high-volume breakdown off the peak in late February that turned the stock into a late-stage failed-base (LSFB) short-sale set-up, it has been tracking sideways in five-week bear flag. Currently WB is clinging to the underside of the 10-day, 20-day, and 50-day moving average confluence. This may put it in a lower-risk short-sale entry position here using the 50-day line as a guide for an upside stop.

 

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Alibaba (BABA). JD.com (JD), and Momo (MOMO), all not shown here on charts, remain above their 10-day and 20-day moving averages and within overall uptrends. As long as they hold near-term support along these two key moving averages, I would not consider any of them to be sells. The exception being, of course, unless one is seeking to take profits into extended upside moves in the style of a pro-active swing-trader.

While I would like to see Snap (SNAP) undercut the prior 18.90 absolute low in the pattern and rally as a potential undercut & rally long set-up, the objective reality is that it is trying to do it right here. On Thursday, the stock dipped below the prior week’s 20.03 low and then rallied to close sixteen cents above that low.

Volume picked up on a relative basis as the stock closed above the mid-point of its Thursday’s daily trading range. So, the U&R set-up here has been triggered, using the 20.03 price level as a selling guide. The other option is to use the Thursday intraday low at 19.81, one percent lower, as a slightly wider selling guide.

 

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Square (SQ) was an outlier on Wednesday when it posted a strong-volume pocket pivot. That move was fueled by speculation of a buy-out, and with no concrete news forthcoming the stock immediately gave up those gains on Thursday.

Thursday’s immediate give-up took the stock one penny back below its 20-day exponential moving average, but selling volume dried up to -24% below average. I wouldn’t call this an outright failure, since the general market action on Friday was also a factor. SQ remains within what is now a seven-week base with earnings coming up and expected on May 3rd.

I would still consider a pullback to the 50-day moving average to be likely, although it is rising steadily and isn’t that far below the stock’s current price. Whether the buy-out rumors turn out to be true or not isn’t clear, but I suppose one could always buy a few shares here and use the 50-day line as a selling guide.

 

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For newer members: Please note that when I use the term “20-day moving average,” “20-day line,” or “20-dema” I am referring to the 20-day exponential moving average. I use four primary moving averages on my daily charts: a 10-day simple, 20-day exponential, 50-day simple and 200-day simple moving average.

On Wednesday, I wrote that, “I don’t like the look of a lot of stocks on my long watch list currently, and this leads me toward a more cautionary stance on the long side. The bottom line is that I don’t see all that much that I think I need to be long right now…” That remains the case over this long Easter Holiday weekend, and is further reflected below in my notes on other long ideas discussed in recent reports:

Activision (ATVI) reversed at its 20-dema on Thursday and closed at a lower low. This would constitute a violation of the moving average for those using it as a selling guide.

Arista Networks (ANET) is holding support at its 20-dema. That would serve as a tight selling guide given that the 50-day line is much further down in the pattern.

Bioverative (BIVV) remains near its post-breakout highs. The 10-day or 20-day moving averages remain near-term references for support/selling guides.

Checkpoint Software (CHKP) posted an outside reversal to the downside on Thursday on declining volume. Earnings are expected on April 27th, so it’s not likely that any major moves will develop before then.

Electronic Arts (EA) may be morphing into a short-sale target here after reversing hard off the 90 price level on much higher selling volume and closing below its 10-day and 20-day moving averages. This might just be a short here, using the 90 price level as a tight upside stop.

Incyte Pharmaceuticals (INCY) has regained its 10-day and 20-day moving averages, and it did so on Thursday as the general market was getting hit. This is a constructive sign, and the 50-day line would remain your maximum selling guide.

Take-Two Interactive (TTWO) has now violated its 50-day moving average, which is a sell signal.

Veeva Systems (VEEV) remains near its recent highs, and the 20-dema remains a nearby selling guide.

Members might have noticed that within my notes on long ideas discussed in recent reports, above, there may be a group short theme emerging among the video-gaming stocks. Both Activision (ATVI) and Take-Two Interactive (TTWO) has violated their respective 20-dema and 50-day moving averages. This may make both, not shown here on charts, short-sale targets right here using the 20-dema in the case of ATVI and the 50-day line in the case of TTWO as tight upside stops.

And then there’s Electronic Arts (EA), which reversed off its highs on Thursday with volume ticking up to 12% above average. The close just below the 20-dema might make this shortable here using the 20-dema as a tight upside stop. This sort of short-sale entry is a little trickier since there has not been a wholesale breakdown in the stock just yet. What is noticeable, however, is this group theme where all three of these video-gamers, ATVI, EA, and TTWO are starting to show subtle signs of initial cracking.

My hunch may be all wet here, but I would keep a close eye on this group since they have represented an area of leadership in this current market rally. If the general market begins to correct further, then these names could come down further as well in a group move.

 

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In Wednesday’s mid-week report, I discussed Splunk (SPLK) as a short-sale target near the confluence of its 10-day, 20-day, and 50-day moving averages. The next day, on Thursday, the stock peeled away from this moving average confluence on the downside as selling volume picked up sharply. This took it down close to the 200-day moving average which might cause a short-term bounce.

Otherwise, a clean break through the 200-day line would help confirm this as something more than a short scalp down to support at the line. SPLK isn’t expected to report earnings until late May, so there is plenty of time for the stock to move lower if it wants to.

 

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Workday (WDAY) is another cloud name to keep an eye on. As I mentioned in my Wednesday mid-week report, the stock is looking like a POD-failure set-up similar to SPLK. The precise failure at the right-side peak of the POD occurred back in late February when the stock gapped down on huge selling volume after earnings.

On Wednesday, news that Target (TGT) had selected their Human Capital Management system to streamline its human resource operations sent WDAY launching up through its 50-day moving average on heavy volume. However, that move did not hold above the line as the stock reversed from the intraday highs and closed near the lows of the daily price range.

Thus, it looks like the news was simply sold into, and on Friday another attempt at the 50-day moving average was pushed back on lighter volume. This may put the stock in an opportunistic short-sale position using the 50-day line as a guide for an upside stop.

 

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GrubHub (GRUB) rallied up through is 50-day moving average on Wednesday as noted in my report of that day, where it reversed off the intraday highs and closed back below the line on higher trading volume. Despite the big price move, caused by an analyst’s upgrade, volume on Wednesday was still only about average.

On Thursday GRUB made another run at the 50-day line but was turned back on light volume as buyers apparently headed off to the Hamptons for the holiday weekend. That provided short-sellers with a convenient entry at the 50-day line early in the day, but the stock remains in short-sale range here using the 50-day line as your guide for an upside stop.

 

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Thursday’s sell-off was provided a ready alibi in the alleged unwillingness of investors to hold stocks over the holiday weekend due to the potential for negative news amidst all the current geo-political tension. So, if we get through the Easter holiday without any noteworthy and negative news, Monday might see stocks open to the upside.

That would not surprise me given how beat up many stocks are after this past week. Airlines, financials, oils, industrials, steels, and semiconductors have all taken it on the chin over the past few days, and some may be due for a bounce. On its face, this past week’s action would not appear to bode well for the general market going forward, however.

In terms of handling any current long positions, I reiterate that all one needs to do is stick to their trailing and absolute stops. If things continue to deteriorate then the market will simply force you out of your positions. On the short side, where some short-sale targets have become slightly extended to the downside (or worse), a market bounce might bring some of these into more favorable short-sale range. Stay tuned.

Gil Morales

CEO and Principal, Gil Morales & Company, LLC
Managing Director and Principal, MoKa Investors, LLC
Managing Director and Principal, Virtue of Selfish Investing, LLC

At the time of this writing, of the stocks mentioned in this report, Gil Morales, MoKa Investors, LLC, Virtue of Selfish Investing, LLC, and/or Gil Morales & Company, LLC held no positions, though positions are subject to change at any time and without notice.

Gil Morales & Company, LLC (“GMC”), 8033 Sunset Boulevard, Suite 830, Los Angeles, California, 90046. GMC is a Registered Investment Adviser. This information is issued solely for informational purposes and does not constitute an offer to sell or a solicitation of an offer to buy securities. Information contained herein is based on sources which we believe to be reliable but is not guaranteed by us as being accurate and does not purport to be a complete statement or summary of available data. Past performance is not a guarantee, nor is it necessarily indicative, of future results. Opinions expressed herein are statements of our judgment as of the publication date and are subject to change without notice. Entities including but not limited to GMC, its members, officers, directors, employees, customers, agents, and affiliates may have a position, long or short, in the securities referred to herein, and/or other related securities, and may increase or decrease such position or take a contra position. Additional information is available upon written request. This publication is for clients of Gil Morales & Company, LLC. Reproduction without written permission is strictly prohibited and will be prosecuted to the full extent of the law. ©2008-2017 Gil Morales & Company, LLC. All rights reserved.