The Gilmo Report

October 12, 2014

October 11, 2014

Expect the unexpected. That has been one of my favorite watch-phrases in this environment of late 2014. While Wednesday’s furious upside undercut & rally move had all the appearances of at least being able to generate a bounce that could carry up to the 50-day moving average on the NASDAQ Composite and S&P 500 Indexes, Thursday’s reversal and break to lower lows, even on slightly less volume, put an end to that bullish argument. Interestingly, despite the market getting whacked on Thursday, the Gilmo “Fab Four,” consisting of El Pollo Loco (LOCO), Mobileye (MBLY), Palo Alto Networks (PANW), and Twitter (TWTR) were all up at least 1% or more, a lot more in MBLY’s case early in the day, providing for at least a profitable exit.

By the close, PANW had even managed to stay positive on the day, while TWTR was down slightly. MBLY was crushed Friday after Tesla Motors’ (TSLA) ridiculously over-hyped “D” announcement did not include anything that involved MBLY’s driver-assisted/driverless technology. Thus as I tweeted to members around mid-day on Thursday the market’s break to lower lows represented a tidal move against which it would be foolish to try and take a stand with any long positions. It was a simple matter to exit long positions and quickly shift back to the short side, although I have to admit that at the open on Thursday that was the last thing I expected to be doing that day. Expect the unexpected.

The secret to making money in the markets isn’t about being right all the time, but knowing when you are right and playing your hand to maximum effect when you are, and likewise knowing when you are wrong and reversing course as necessary, and the sooner the better! Nobody taught me this lesson better than Bill O’Neil. Way back when I ran money for him, I would often watch this uncanny ability of his play out in real-time as he quickly sensed when he was wrong and shifted direction in a heartbeat.

One of the most well-known examples of this is discussed in the book I co-authored, “Trade like an O’Neil Disciple” where I discuss O’Neil’s view on October 23, 1999 that the “market is through.” At that time the indexes were selling off hard and it looked like we were headed for a deeper correction or even a bear market. Four days later the market turned back to the upside and O’Neil and all his internal portfolio managers, of which I was one, immediately shifted to the long side, catching what became the final parabolic rocket ride through the last two months of 1999 that eventually led to the big market top March 2000. During those two short months in my own account, I went from being up about 36% in October 1999 to up over 1,000% by year-end.

Thursday was one of those days where quickly sensing the error of my ways by thinking we were setting up for at least a tradable rally back up to the 50-day moving average on the NASDAQ and S&P 500 proved to be fortuitous. Fortunately, the long positions I came in with overnight Wednesday all were higher at the open on Thursday, offering favorable exits as I avoided the eventual tidal wave of selling on Friday. Hopefully members were able to follow my real-time observations on Twitter and take action themselves as necessary or warranted, because things deteriorated even more sharply on Friday, particularly with respect to the action of individual stocks we’ve been following in recent reports.

Getting to the price/volume action of the major indexes, the NASDAQ Composite Index kissed its 200-day moving average early in the day on Friday before generating an intraday bounce that eventually failed, rolled over, and pushed back down through the line, as we can see on the daily chart, below. The Dow led the intraday bounce on Friday, but this action struck me more as big money moving into safe big-cap names in preparation for further downside than anything else. That assessment was correct as the indexes reversed back to the downside and closed at their lows on Friday with volume picking up. We can see from the chart that the NASDAQ has now undercut the early August lows and the 200-day moving average, which could put it in position for an undercut & rally if the indexes gap down on Monday morning, but that is not clear just yet.




Likewise with the S&P 500 Index which fared a little better than the NASDAQ, holding right at its own 200-day moving average and August lows. Movement to the downside on Monday will put it in the position of cleanly undercutting the moving average and the August lows and could perhaps set up some sort of reaction rally, which short-sellers should be aware of and alert to as we begin the trading week on Tuesday. On the other hand, given the extreme weakness seen on Thursday and Friday, the market appears to have some downside velocity behind it, and there is always the chance of some sort of “crash” scenario to start the week. But while that is possible, investors should be aware of the positions of the indexes here as they undercut the 200-day lines and the August lows, especially if you are a short-seller. The bottom line is that we have no idea of knowing exactly for sure how things will play out, and knowing the lay of the land, so to speak, helps maintain the proper awareness.




With the S&P 500 down 5% off of its peak and the NASDAQ 7%, my tendency is to think that further downside awaits the market one way another. During the bull market that began in 2009 we have seen the market correct more severely after the Fed has ended each of its separate QE money-printing programs. The latest incarnation amounts to nothing more or less than sleight-of-hand money-printing in my view. The monthly bond purchases that started out at $40 billion per month in September 2012 before being raised to $85 billion in December 2012, but which have been incrementally “tapered” since June 2013, is expected to end this month.

If the market does what it did after QE1 and QE2 ended, we might expect something similar in this case as well, which in my view would be a correction of at least 10%.

To get a sense of how bad Friday was, look at the daily charts of the Gilmo “Fab Four” and how they fared. On Thursday all of these stocks were rallying even as the market began to sell off early in the day, and not too long after the close the market looked like it might make a comeback. Had the comeback continued on Thursday, then these stocks, which were already acting well that morning, would probably be the place to be on the long side. But as the market broke to lower lows after mid-day, it was time to read the writing on the wall and back away from the long side. That move turned out to be the correct one as stocks across the board, including the Fab Four, were absolutely pulverized on Friday.

Palo Alto Networks (PANW) was looking like a strong flag breakout a week ago, but has now rapidly morphed into a late-stage flag base-failure situation as it busted below its 20-day moving average and the $100 price level on heavy volume Friday. This turns it into a short-sale target on the basis of the late-stage failed-base (LSFB) setup, using rallies into the 20-day moving average or the prior breakout point at 99-100 as optimal short-sale zones. The stock closed Friday 4% above its 50-day moving average, as we can see on the daily chart, below. So if one did try to short the stock here using a very tight stop then a bounce off the 50-day moving average might be likely.

The other option is to simply wait for a bounce back up to the 20-day moving average at 97.99. If PANW is in fact going to fill out as an LSFB there will be plenty more opportunities to short the stock. In addition to being a potential LSFB, PANW also fits Livermore’s Century Mark Rule in reverse. This is used to short stocks that fail to hold a key century mark price level, in this case the $100 price level.




Twitter (TWTR) was looking very good on Wednesday after flashing a continuation pocket pivot off of its 10-day moving average that came on the heels of last Friday’s flag breakout on strong volume, which we can see on the daily chart, below. This flag breakout failed in brutal fashion on Friday as TWTR plunged through the 20-day moving average and broke -8.84% to the downside, closing right very near its lows for the day on heavy volume.

When good-looking stocks turn bad in the blink of an eye, the market is giving you very specific feedback about what to do, which is to sell quickly and get out of the way. Of course this was evident on Thursday, and the TWTR position I was carrying overnight on Wednesday was sold while it was up on Thursday before things got ugly. Once again, a demonstration that in the stock market there are two types of investors: the quick and the dead.




Investors were not pleased with the fact that TSLA’s big product announcements on Thursday night didn’t fixate on Mobileye’s (MBLY) driver-assisted/driverless technology, and they hammered the stock on a big volume Friday, sending the stock on a big gap-down breakout failure, as we can see on the daily chart below. As I wrote on Wednesday, MBLY’s recent advance to new highs was caused by speculation that TSLA would be announcing some sort of driverless version of their Model S using MBLY’s technology, and that if one were going to try and buy the stock in any continued market bounce then doing so on weakness was the best approach.

Of course, the state of the market over the past two days and the action of MBLY on Friday sends all of that right out the window. It does, however, demonstrate how even the hottest of stocks will get clocked when the general market and over-hyped news events do not go its way. This highlights the fact that while certain highly dynamic and volatile “new merchandise” stocks come with a lot of reward potential, the risk is often commensurate, and investors always need to have an exit plan if things go awry. Sitting there like Humpty Dumpty ready to take a great fall from which all the King’s men and the King’s horses can’t put you back together again is not advisable. Just ask anyone who was holding GT Interactive (GTAT) earlier this past week!




El Pollo Loco (LOCO), surprisingly enough, held up the best of all four on Friday, holding its 50-day moving average on very light volume. As we can see on the daily chart, below, LOCO now has a 50-day moving average of volume as well as of price, and this makes it easy to see that the volume over the past several days has been drying up in the extreme. With the general market in the state it is currently, buying into this here is not advisable, unless the market were able to find its footing and begin a rally attempt. However, in a continued correction, if LOCO is able to hold up as well as it has so far, without splitting wide open as, say, MBLY did, then it should be monitored on one’s buy watch list.




Failing to expect the unexpected, I didn’t expect my short-sale target stocks to come into play until at least Friday or this Monday, as I was looking for the market bounce to carry for a day or two, at least. As I tweeted on Thursday, however, Tesla Motors (TSLA), failed to hold its 50-day moving average as volume was picking up, and at that point I considered the stock a short, even in the face of Thursday night’s big “D” product announcement. I even held a short position in TSLA overnight Thursday and benefited from the stock’s gap-down on Friday after it failed to impress investors. As I tweeted early in the day on Friday, TSLA was a shortable gap-down using the high-of-day (HOD) at 245.89 as a guide for an upside stop.

After breaking down below and undercutting the 235.65 low of October 1st right after the open, a logical intraday undercut & rally move, TSLA went back up as high as 242.65 before rolling over again and closing near the lows, as we can see on the daily chart, below. That rally back above the 240 level was the last chance to short it, in my view, as it looks primed to move lower from here as it completes the initial phase of a late-stage failed-base short-sale set-up.

We’ve discussed in previous reports that the entire right side of this LSFB set-up is also a fractal head and shoulders formation. This week’s earlier move back above the 50-day moving average, while also putting the stock in position to confirm on the long side, ended up forming the peak of a second right shoulder in the fractal H&S en route to a pending neckline breakout that is also busting through the prior cup-with-handle breakout point, as I’ve highlighted on the chart. If one can handle the risk, this is still within about 4% of the 245.89 stop-out point as a shortable gap-down. Of course, my preference was to jump on it Thursday as it broke down through the 50-day moving average, but this is still a workable trade for those who are willing to accept the risk parameters thereto.





Netflix (NFLX) also reverted back to its POD-failure-like ways and broke back down through its 50-day moving average on heavy volume Friday, as we can see on the daily chart, below. The breakdown occurred on the heaviest selling volume since the big-volume break off the peak in mid-September, and at this point NFLX again morphs back into a short-sale target after flashing a pocket pivot off the lows last week. With the high-volume break occurring at the 50-day moving average Friday, as I tweeted early in the day, NFLX was shortable as soon as it broke below the line. However, based on Friday’s close, it is still within 2% of the 50-day line, hence can still be shorted here using the 50-day line as a quick upside stop.




LinkedIn (LNKD) could not follow through on Wednesday’s pocket pivot supporting move off the 200-day and promptly failed at the 10-day moving average on heavier selling volume, as we can see on the daily chart, below. Like NFLX, LNKD on Friday traded the heaviest volume in the pattern since its own mid-September break off the peak. In hindsight this could have been shorted on Thursday at the 10-day line, but in this position it is sitting just above its 200-day moving average, thus a rally up to overhead resistance at the 65-day exponential moving average at 203.37 would provide an optimal short-sale entry point.

However, the stock could also continue lower and undercut the 200-day line. If you look carefully at the daily chart you will notice that the pattern since mid-August has formed a fractal H&S that also takes the form of an inverted cup-with-handle where the handle is in turn also a bear flag, or what I have at times referred to in the past as “walking the plank.” Wednesday’s bounce off the 200-day line represented a downside breakout and fake-out from the bear flag, thus Friday’s action can be seen in this context as a downside “re-breakout” on higher, above-average selling volume. Thus there is a case to be made for further downside next week from here, such that any upside open on Monday might be something to short into, keeping in mind the need for a tight upside stop.




Fractal H&S formations abound as (AMZN) shows on its daily chart, below. On Friday the stock broke out through the neckline of a fractal head and shoulders formation of its own, as we can see on the daily chart, below. This fractal formation in turn makes up the right shoulder of a larger H&S it has been working on since the earlier part of August, as we can see on the daily chart.




The weekly chart of AMZN, below, gives one a better picture of what is going on here on a macro-scale. We can see the primary H&S formation that peaked in early January 2014 and the current secondary H&S formation that has formed since the May lows. The right shoulder of this secondary H&S is where the current fractal H&S is contained, as we saw on the daily chart, above. If the general market continues to trend lower, I would not be surprised to see AMZN eventually take out and undercut the May low at a 284.38. In the meantime, any rally back up into the fractal neckline at 315 would be shortable using a tight 4% stop at the 20-day moving average.


GR101214-AMZN Weekly


SolarCity (SCTY) was another one of these short-sale targets of ours that found stiff resistance at its 10-day moving average, as we can see on the daily chart, below. My thinking on Wednesday was that it would try and rally with the market, perhaps putting it in a better position for a re-entry short-sale trade, but with the market failing on Thursday and Friday, more downside next week may take it down to the lows of its big POD-with-handle formation, which I’ve highlighted on the chart.




Activist investor Carl Icahn got Apple (AAPL) moving on Thursday when his organization released an open letter to Apple management that was in fact a thinly-veiled research puff piece implicitly intended to bolster Icahn’s 53-million-share AAPL position. He believes the company is worth $203 a share, but so far investors don’t seem to agree with him to the point where they are willing to bid the stock sharply higher. Short-term, AAPL was a stop-out if one was trying to short it around the 50-day moving average, but pump pieces aside, we can see on the daily chart, below, that the stock met with selling on Thursday as it closed near the lows on above-average volume. Icahn’s $203 price target wasn’t compelling enough to send the stock even as far as the near-term highs, as I’ve outlined on the chart.

And while I am willing to short the stock into rallies up to this resistance, a breakdown through the 50-day line on heavy volume would help confirm my theory, which, objectively speaking, remains unproven for now. Icahn’s projections of 35% earnings growth for AAPL next year don’t jibe with current analysts’ estimates which show that annual earnings growth over the next four years is expected to come in at 11%, 15%, 12% and 2%. Frankly, I consider Icahn’s “estimates” to be borne more of a need to pump up his existing position in the stock than a truly objective assessment. But I suppose you can’t blame the guy for trying. In addition to the “Icahn-pumping,” AAPL has also likely benefited from a “safety bid” of sorts lately as money looks to the stock as a stable, liquid, established and quality big-cap name.

My view is that AAPL is currently a 10% earnings grower and a single-digit sales grower trading at 14 times forward 12-month estimates, and if that kind of dynamic growth wows you, then perhaps you can go ahead and buy it. For my money, I tend to think that if the general market continues lower, AAPL will be headed lower as well, and a break of the 50-day line would confirm my theory, end of story. Meanwhile, AAPL announces earnings near the end of the month, and that could provide the needed catalyst one way or the other.




As I’ve gained experience over nearly a quarter-century of trading the markets, I have become much better at accepting and utilizing market feedback, especially when the market proves me wrong at any given point in time. On Wednesday after the close I had ample reason to at least expect a rally up to the 50-day moving averages by the S&P 500 and NASDAQ Composite Index, and I had a very small number of stocks that would serve as vehicles in such a move. As I wrote on Wednesday, these long positions could turn out to be little more than short-lived, short-term trades. Even that was very rapidly proven wrong by about mid-day on Thursday, and the market’s feedback gave me a clear signal to dump my long positions, all of which were up on the day at the time, and shift back to the short side.

At the same time, I saw TSLA and some other names start to break down through key support levels at which point they became shortable. With QE3, also known as QEternity, coming to an end, this correction could follow the paths of prior post-QE1 and QE2 corrections and extend further to the downside. At the very least, the current real-time action is enough to tell me that the long side is out of the picture in a big way for now, outside of perhaps trying to short-term trade any reaction bounces. Otherwise cash is king, and for those who have the proper experience and temperament, the short side is back in play.

When the markets change as quickly as they do, my view of the market based on what I am seeing in real-time has the potential to change quickly as well, and so members should follow me on Twitter for my real-time market observations in this regard. While I most certainly do not intend my tweets as investment advice or recommendations, I believe my real-time observations can provide useful information to Gilmo members who understand their context within the broader framework of my twice-weekly written reports.  You can follow me on Twitter at


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 positions in AAPL, NFLX, and TSLA, though positions are subject to change at any time and without notice.

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