The Gilmo Report

April 27, 2014

April 26, 2014

So far the market’s bounce and rally off of last week’s lows is playing out as I’ve been expecting. The rally following a sharp correction in the NASDAQ Composite Index that saw the index undercut its early-February lows and bounce right off of its 200-day moving average coincided with a number of leading stocks breaking down off of their recent peaks to form what have appeared to be the right sides of “heads” within potential head and shoulders topping formations. The market rally over the past couple of weeks has allowed many, if not most, of these stocks to build logical right shoulders as they go about the process of building and completing potential H&S formations. This has been the essential theme behind my current market view, and one that I’ve articulated frequently in recent reports, and so far has provided a relatively accurate context from which to view the action over the past two weeks. As we can see on the daily chart below, the NASDAQ appears to be rolling over again after a higher volume stalling day on Thursday after the index gapped up sharply in the morning thanks to big earnings-related gaps in Apple (AAPL) and Facebook (FB). Both stocks gapped up after announcing earnings Wednesday after the close, and while AAPL held its gap but remains below resistance at around the 570 price level, FB reversed in a move that looks very much like a classic right shoulder formation, but more on that later. In the meantime the market remains in a correction, primarily based on the action of the NASDAQ and its associated former leaders.




The S&P 500 Index, shown below on a daily chart, remains in a position that is less than 2% below its recent all-time highs, creating something of a bifurcated market as oil-related and safer, low-P/E big-cap names take on a sort of relative leadership role. As I’ve written previously, the relative strength of the S&P 500 vs. the NASDAQ and the strength in what I see as mostly defensive and low-P/E, established, big-cap names reflects a “hunkering down” by institutions as they rotate into areas that perhaps have less downside in any potential bear market. The S&P 500 suffered a distribution day on Friday as the index rolled over and met up with its 50-day moving average on slightly heavier volume. If the S&P 500 cannot hold the 50-day line, then we are certainly headed for a retest of last week’s lows.

While “tensions” in the Ukraine are blamed for the market’s sell-off on Friday, we have to remember that the initial breakdown off the peak in early March was also attributed to events in the Ukraine. As I’ve discussed many times, I believe such news merely provides an “alibi” for selling. Once the news subsides, the market then has an excuse to bounce and such a bounce is then sold into again. This provides institutions with the cover they need to conduct their distribution of stock into the market. The steady and continued deterioration in former leaders provides some evidence in support of this theory. So while events in the Ukraine this week might cause the market to do this or that, the essential theme here is that former “hot” leaders, even big-cap NASDAQ leaders ranging from Tesla Motors (TSLA) to Netflix (NFLX) to Facebook (FB) to (AMZN) to (PCLN) all continue to break down further. This is most definitely not the stuff from which bold, new bull market phases arise. While a couple of my long ideas have done okay since two Wednesdays ago, the bottom line for me is that the short side has been and remains far more profitable, and this past week was no exception.




As I started writing three weeks ago in my April 2nd report, a mass of former leading stocks had broken down sharply off of their late February/early March price peaks in moves that had the appearance of forming “heads” within overall potential head and shoulders topping formations. As I wrote back then, many were at or approaching points in their patterns where a logical rally that occurred at the same time as the general market was able to finally generate some sort of reaction low and rally that would logically enable these stocks to build right shoulders and bring them closer to completing full-on H&S set-ups. So far this action is playing out as I expected.

On Wednesday I discussed the action in Netflix (NFLX) as setting up a right shoulder rally within an H&S pattern that was so far 2/3rds completed with a left shoulder and a head evident in the weekly chart, shown below. NFLX’s earnings “surprise” on Monday after the close set up a rally right into its 65-day exponential moving average on the daily, not shown, and the 10-week moving average on the weekly. These moving averages also coincided with the peak of the left shoulder in the pattern, as I discussed in my report of this past Wednesday. NFLX reversed hard off of the peak on Tuesday and has continued lower over the past two days, showing up on the weekly chart as a huge-volume reversal off of the 10-week moving average that serves to form at least the first right shoulder in the pattern. As NFLX moves to the 320 price level, I’m looking for it to undercut the 312 low of last week before it might generate some sort of short-term reaction bounce. Overall, however, NFLX appears to be setting up in a head and shoulders formation that likely indicates further downside in the coming days and/or weeks. Notice also how classic this H&S formation is filling out as the general pattern of volume from the furthest left side of the pattern is showing increased downside volume.


GR042714-NFLX Weekly


In fact, there are a number of former leaders that had right shoulder rallies this past week and last, and all of them are showing the classic head and shoulders volume pattern where volume increases from left to right in the pattern. In my report of this past Wednesday, I noted the after-hours gap-up move in Facebook (FB) following its “blowout” earnings report, and discussed the possibility of this move failing to form a right shoulder in an overall head and shoulders formation that was still potentially “in-process.” FB peaked out below its 50-day moving average on the daily chart and reversed right off the 10-week moving average on heavy selling volume, as we can see on the weekly chart, below. As I see it, FB had a big-volume churning and stalling week three weeks ago on the chart. Volume picked up sharply that week but the stock closed in the lower half of its range after making an attempt to rally up to its 10-week line.  Within the context of the formation of a prior potential “head” over the prior four weeks, that was not constructive action. In my view, FB is headed for the 200-day moving average at around the 51.82. The 40-week line on the weekly chart is currently 53.13, so a reaction low might be achieved somewhere within those two price points. FB’s H&S formation differs slightly from the “classic” set-up in that the right shoulders is slightly above the left shoulder, but I have seen patterns like this work on the downside in many, although not the majority, of cases.


GR042714-FB Weekly


If we investigate FB’s daily chart, below, we can see the precise nature of the action on that big-volume stalling week three weeks ago. It occurs right after the vertical gray “oversold” bars show up on the chart as the index makes a strong-volume move back up through the 65-day exponential moving average but falls short of the 50-day line. This is met by a big outside reversal the very next day on even heavier volume, sending the stock back to its recent three-week lows. On Thursday, FB repeated this pattern by again attempting to move back above the 65-day line and up towards the 50-day line before staging another big outside reversal day and then continuing lower on above-average volume on Friday. FB has also gone “Code Red,” which in general is not a “constructive” development. While the stock might find temporary support around the 56 level and the confluence of lows over the past three weeks that can be seen on the chart, my near-term target for the stock remains the 200-day moving average.


GR042714-FB Daily (AMZN) also remains a classic head and shoulders top that already “broke out” through the neckline four weeks ago, as we can see on the weekly chart below. AMZN has a very nice shortable rally this week as it pushed right up into the neckline and the 10-week/40-week moving average confluence that now shows the 10-week line moving below the 40-week line for a bearish “black cross.” AMZN briefly rallied up to around 355 following the announcement of more operating losses on Thursday after the close, but I saw this as a prime shorting opportunity and was actually able to short some shares into the rally after-hours.

The stock came all the way back in to the 337 level before after-hours trading ended, and I decided to bank my profits on what was a very short after-hours trade. In hindsight, I should have just sat, since the stock opened at 316.25 on Friday morning. This was a shortable gap-down using the 316.25 price level as an upside stop, and the stock remains within range of this upside stop-out level even after closing at 303.83 on Friday, about 4% below the 316.25 price level. I would look at any rally back up towards 310 as a lovely opportunity to short the stock as the huge-volume gap-down, in my view, likely portends further downside for the stock. As one astute investor pointed out, it represents the most overvalued “not-for-profit” organization on the planet. Notice the textbook volume pattern on AMZN’s H&S pattern as it increases fairly sharply from left to right in the pattern.


GR042714-AMZN Weekly


Pandora Media (P) had completed a left shoulder and a head in a potential H&S formation last week, setting up a rally earlier this past week that took the stock right up into the 30 price level, an area that has represented upside resistance previously in the pattern, as we can see on the weekly chart, below. This served to form the necessary right shoulder in the pattern, and P’s demise was complete by the time it announced earnings on Thursday after the close. P gapped down on Friday morning, which became a shortable gap-down move using the 25.87 intraday high as your upside stop. In my view the stock is headed towards the $19 price level, so I would use any kind of bounce back up towards 24-25 as an opportunity to short the stock with the idea of using the 19 level as your downside price target. Again, as P completes the right shoulders and fills out its H&S formation, note the textbook volume pattern that increase from left to right in the pattern.


GR042714-P Weekly


A couple of weeks ago I pointed out the five straight weeks in the weekly chart of Celgene (CELG), shown below, where the stock closed at or near the weekly low with volume picking up each week. To me this indicated severe distribution in the stock as institutions began piling out. This has been followed by two weeks of upside in the pattern that saw CELG bump into resistance right at the blue 10-week moving average on heavier volume vs. last week’s feeble-volume bounce. The stock closed in the lower half of the weekly range, constituting clear churning and stalling in the stock that in my view precedes further downside in the stock. Notice that CELG formed a bearish black cross four weeks ago as the 10-week line moved below the 40-week line, and the volume pattern has the textbook left-to-right increase. Volume over the past two weeks has been quite light on the bounce following eight straight down weeks as the stock broke down through the 150 price level.


GR042714-CELG Weekly


If we drop down to a more detailed view on the CELG daily chart, below, we can see that Friday’s rally took the stock right up into the top of the “falling window” of Thursday’s gap-down move, essentially “filling the gap” before reversing to close near the lows of the daily price range. It seems that CELG finds some support along the 135 lows over the past three weeks, but my guess is that it will eventually blow through this support in any continued market correction. Thus for now I would be content to short the stock here using the 144.72 intraday high of Friday as a quick upside stop. If CELG were able to manage a rally up towards what has been short-term resistance at around the 148-150 level that would be an even more optimal entry point as this would also bring the stock up near the descending 10-week moving average, but it is not clear to me that this will happen. Thus I think a strategy of shorting it here with a quick stop at 144.72 works with the idea of shorting the stock near the 10-week line if a rally were in fact able to carry that high. My guess is that such a rally attempt would need some help from the general market, so how one plays this out could be dependent on the action of the general market this week. Just stay flexible and opportunistic, understanding the overall picture in CELG, which is quite bearish based on the action shown on the weekly chart, above.


GR042714-CELG Daily


If one looks at a chart of the Market Vectors Biotech ETF (BBH), not shown here, one might notice that it has formed a big head and shoulders formation that is indicative of the group as a whole. In my view, the bio-tech sector is likely forming a major top, as the group has been a very hot, leading area of the market throughout the bull phase from 2009 to the present. But now all the big-stock bio-techs are showing H&S formations, and Gilead Sciences (GILD), which I have been campaigning on the short side for the past seven weeks, is no exception. GILD is a bit stronger however, after gapping up on an alleged earnings “blowout” Wednesday morning. The move, however, simply carried the stock right up to the 10-week moving average, where it found resistance as we can see on its weekly chart below. Volume was up for the week, but in the context of the huge-volume breakdown three weeks ago that took the stock below its 40-week moving average, it remains suspect, and may simply turn out to form the second right shoulder in what appears to be an overall H&S pattern with the textbook increasing left-to-right volume pattern.


GR042714-GILD Weekly


The daily chart of GILD, below, gives us a better look at the Wednesday earnings-related gap-up move and how it has played out so far. I took advantage of the move right up to the 50-day moving average on Wednesday morning to take a short position in the stock, which I held overnight into Thursday where the stock continued down to its 20-day moving average before bouncing on an intraday basis and actually closing slightly positive on the day. Now GILD is simply moving tightly along the 65-day exponential moving average as volume remains above average. So while it is trading heavier volume it is not able to make that much upside progress after a blowout earnings report that saw sales of GILD’s hot new Hepatitis C drug, Sovaldi, come in at $2.26 billion vs. their prior guidance of $1.55 billion. GILD reiterated its prior guidance for 2014, so despite the huge upside surprise in Sovaldi sales it doesn’t appear that it will have any substantial impact on 2014 earnings going forward. The trick here is determining whether GILD is stalling here or whether it is forming a short flag before it tries to go higher. Notice that 3 out of 4 of my indicator bars at the top of the chart have turned blue, so there is some strength on the rally off of the lows of about two weeks ago.

Thus I think GILD remains in flux, but with the rest of the bio-tech group acting so weak and in unison, I would continue to look at rallies up into this area between the 65-day and+ 50-day lines, between 74 and 76, as potentially shortable using the 76 level as a convenient hyper-stop. Remember that when you are short it is even more important to adhere to your stops, and it is usually, but not always, my preference to try to find entry points where I can set a very tight upside stop. While it is not necessarily a perfect approach it minimizes damage, because damage can often get out of control very quickly on the short side if one is not careful. While the downside profits can be quite exciting, the upside reaction rallies can be short and very sharp, so the problem of shorting in general is one of trying to capture most of the generally sharp downside moves while for the most part avoiding the sharp upside moves.

This is one aspect that I will cover in detail in the next book that I have just started writing with my colleague Dr. Chris Kacher and which has the working title, “Turn to the Dark Side with the O’Neil Disciples: Short-Selling and Contra-O’Neil Techniques.”


GR042714-GILD Daily


Adding further evidence to the premise that the entire biotech sector is in one big head and shoulders top is provided by perhaps the biggest of the big-stock biotech leaders, Biogen Idec (BIIB), shown below on a weekly chart. Prior to last week, BIIB had completed a left shoulder and a head in a potential H&S formation that was still 2/3rds in-process. That right side of the head occurred as the stock traded sharply lower for four weeks in a row and closed at or near the weekly low each week on heavy selling volume. After announcing earnings this week that enabled a short rally before the stock found resistance at the 10-week moving average, BIIB completed a right shoulder in the pattern as it reversed to close at within a quarter of the weekly low on above-average selling volume for the week. Notice also that the textbook left-to-right volume pattern is evident, as I’ve taken the time to actually annotate on this chart.


GR042714-BIIB Weekly


On the daily chart of BIIB, below, you might notice that the stock’s move up to the 65-day exponential moving average coincides with the move up to the 10-week line on the weekly chart, above, and that this is the case for GILD as well. When you are watching short-sale target stocks rally, you have to watch both the 50-day on the daily and the 10-week on the weekly as potential points of upside resistance and be aware of where those are price-wise. Remember also that stocks don’t always stop exactly at a particular moving average, so I tend to look at moving average lines as delineating the mid-point of a “fuzzy” price zone around the moving average. Like GILD, BIIB tried to hold along the 65-day line for a third day on Thursday after announcing earnings on Wednesday, but by Friday the stock rolled over as it looks set to retest the 200-day moving average near the 272 price level.

If I were going to try and short BIIB at this point I would prefer to do it into a rally up towards the 300 price level, although there is no guarantee that this will happen. The main point of this BIIB example is that the entire sector is showing the same type of bearish set-up, namely the H&S topping formation, and in the past when this has happened on a group-wide basis, it tends to be very bearish for the group. We might learn to expect the unexpected, as I suppose the group could right itself and set up for bullish breakouts again, though the current evidence does not appear to argue for such an optimistic resolution. Therefore I will go with the current evidence until newer evidence to the contrary presents itself. So far the action in the bio-tech sector, along with several other leading stocks, argues for more bearish action going forward.


GR042714-BIIB Daily


Looking at another big-stock biotech leader that perhaps was not so much of an old-line, established biotech like BIIB, CELG, or GILD, Pharmacyclics (PCYC) can be seen to have also formed a more extreme left shoulder and head in a potentially big, wide-ranging head and shoulders topping formation. So far the pattern is 2/3rds complete, and we might look for a right shoulder to form when PCYC reports earnings this coming Friday before the open, according to information available on The flip side of this is that the stock is also building a very tight bear flag right along the 90 price level and acts like it wants to break to the downside from here. Maybe one might get some downside shorting the stock here before earnings, but what I would prefer to see is some sort of reaction rally following earnings that takes the stock up closer to the 50-day Often the 65-day dema on the daily can give you an idea of where the 40-week line is on the weekly. Earnings are still four trading days away, so we’ll check in with PCYC in my upcoming Wednesday report to see where it might be setting up at that time. Just another biotech H&S in-the-making.


GR042714-PCYC Weekly


Checking in with the weekly chart of big-stock 3-D printing name Stratasys (SSYS) which I first discussed as a short four weeks ago when it found resistance at the 50-day/10-week moving averages (see April 2nd report), we can see that it keeps finding resistance at the 104-105 price area, as I’ve highlighted on the weekly chart, below. Short-term that looks like a decent short-sale target zone on such rallies, but with volume picking up on Friday the stock might be set to test last week’s 93.70 low in the short-term. Thus one could short the stock here using the 102.43 intraday high from Friday as a quick upside stop. SSYS is expected to announce earnings in mid-May, so an earnings-related rally isn’t in the cards just yet. I could see the stock pushing towards the 89.90 low from October of last year before then if the general market remains weak.

Otherwise you may notice that the 10-week line has just crossed below the 40-week line for a bearish black cross. In the meantime we will see 3-D Systems (DDD) announce earnings this week, and that could provide an impetus for another downside move in SSYS as I see DDD’s H&S formation as more fully-formed and in a position for a downside “breakout.” DDD is expected to announce earnings Tuesday before the open, so keep a close eye on this and its effect on SSYS. I’ll be following this in real-time on Tuesday, so watch my tweets which can be tracked on The Gilmo Report home page.


GR042714-SSYS Weekly


Some fresh breakdowns are occurring in areas outside of the biotech group since, as I’ve already pointed out frequently in recent reports, so many former leading stocks are showing this same type of H&S action. Thus it is not so much a group phenomenon as it is a general theme among all former leading stocks, and of course, this leads us to bearish conclusions about where the market may be headed longer-term. Big-stock financial Visa (V) gapped down hard on Friday as it busted through its 200-day moving average on huge volume, as we can see on the daily chart. This is a shortable gap-down move using the 203.80 intraday high of Friday in conjunction with the 200-day line at 203.54 as your upside guide for a stop. I’m not so sure whether V is a “pinhead & shoulders” type of set-up as much as it is a late-stage failed base breakout set-up. Back in early March V tried to break out from a sort of ladle-with-handle formation but quickly reversed and failed, setting up the LSFB short-sale set-up. V announced earnings on Thursday after the close, setting up Friday’s shortable gap-down.


GR042714-V Daily


V’s cousin, MasterCard (MA), shown below on a daily chart, also gapped down in sympathy to V, as we can see on the daily chart, below, but it isn’t expected to announce earnings until this Thursday before the open. Nevertheless, MA’s technical action, when taken on its face, looks like a shortable gap-down to me, this Thursday’s expected earnings announcement notwithstanding. MA dropped just below the 200-day moving average, so if one were interested in trying to jump on this one for a potential downside continuation before earnings, that is a possibility using the 200-day line at 72.18 as a tight stop. More group weakness as the two big-stock credit card companies, V and MA, start to come unglued.


GR042714-MA Daily


Based on the action of former leading stocks that continue to set up en masse in H&S types of topping patterns as well as other short-sale set-up formations, such as V’s LSFB continuation, it’s hard to be “optimistic” about this market. One can try to get excited over oil names that edge higher, or semiconductors which in my view remain a mixed bag with equal numbers of gaps up and gaps down among the group as we move through earnings season (e.g., see Sanmina (SANM) vs. Freescale Semiconductor (FSL), both not shown, after they announced earnings this past week).

However, I see no reason to be focused on the long side. Particularly, I might add, when the short side remains a very rewarding place to be operating in what is a continuing market correction pending concrete evidence to the contrary. I think I’ve provided enough grist for the short-selling mill, as it were, over the past several weeks to demonstrate the broad weakness in so many chart patterns of former leaders. In the meantime, I won’t go so far as to label myself a bear or a bull, but simply a trader who is riding the dominant trend among individual stocks, which in my view continues to be on the downside.


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 had positions In FB and NFLX, though positions are subject to change at any time and without notice.

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