The Gilmo Report

November 11, 2018

November 10, 2018

My career as an oddsmaker ended abruptly on Friday as the nascent follow-through day, which I gave better than 50/50 odds of working, failed. Of course, I’ve said many times before, I am not a believer in follow-through days as a mindless “all clear” signal to go piling headlong into stocks. As I noted in my last report, the time to be thinking about the long side was before the follow-through day, when the typical long set-ups off the lows were in full view.

The Dow Jones Industrial and the S&P 500 both suffered distribution days on Friday. This comes two days after Wednesday’s so-called follow-through day and theoretically means the follow-through has failed. To me, this is somewhat moot, since I don’t pay attention to the follow-through day to begin with. From my perspective, there is nothing to consider a failure – it all depends on what is going on with individual stocks.

The indexes all sold off reasonably hard on Friday, but intraday the Dow found support at its 50-dma and bounced. This ended up buoying the other indexes, and everything closed up and off the intraday lows, but still in the red. A little more selling into the close brought the Dow down -201.92, or -0.77% on higher volume.

 

GR111118-$INDU

 

The NASDAQ Composite Index just missed a distribution day, which I suppose means that the follow-through in that index on Wednesday is still intact! However, the way big-stock NASDAQ and other tech names have been acting leads me to believe that it really doesn’t matter. In NASDAQ tech land, things have been so bad that the index wasn’t even able to hold Wednesday’s move back above the 200-dma, gapping below the line today.

 

GR111118-$COMPQ

 

The S&P 500 Index held a pullback to its 50-dma on Friday, but still suffered a distribution day as it was down -0.92% on higher volume. It bounced off the 50-dma, so it might even be argued that Friday showed some minor intraday support along the 50-dma. If we see these indexes break near-term support, with the NASDAQ now below its own 200-dma, then I would consider the rally, at least from an index standpoint, to be failing.

 

GR111118-$SPX

 

Back in the day when I was running the institutional advisory group for William O’Neil + Co., various arguments about whether a follow-through day was still “alive” would center around its ability to avoid serious distribution or whether it was more important that it hold the lows of the first rally day or the bottoming day. While it made for great water-cooler banter, these days I don’t really bother with having to validate a follow-through day.

Just show me the stocks, and what I see right now is a very mixed bag with a lot of weakness and a few showings of strength, some of which have been fleeting. Meanwhile, I would consider the 200-dma for the Dow and the 50-dma for the S&P 500 to serve as near-term support references for a true rally failure. In the meantime, the NASDAQ’s inability to hold the 200-dma means that the best short-sale targets still lie among tech and growth names that remain vulnerable to PE-contractions.

With the indexes rallying sharply this week, the action in individual stocks failed to impress. Apple (AAPL) did not hold Wednesday’s undercut & rally move back up through the prior late October low and gapped down on Friday. Whether it can retake that 206.09 low or is simply going to head lower toward its 200-dma remains to be seen.

 

GR111118-AAPL

 

Netflix (NFLX) also failed to hold a U&R move as it dropped back below its prior 315.81 low of October 11th.  Like AAPL, the stock gapped down on Friday as volume picked up sharply and came in at above average. Not an impressive showing, but typical for most stocks that are showing what look more like dead cat bounces than strong recoveries off their lows.

In fact, NFLX could have been treated as a short on Thursday as it approached its 200-dma but turned tail before ever reaching the line. Unless the market can put in a better showing this week, there may be more busted leaders that set up in similar fashion.

 

GR111118-NFLX

 

Amazon.com (AMZN) is holding up better after posting a U&R move back up through its prior mid-October low of 1685.10. It is now pulling in to retest that low and the 200-dma as volume declines. IF it holds, then it may become buyable along the 200-dma, but a breach of the 200-dma would trigger the stock as a short-sale again.

 

GR111118-AMZN

 

What will likely be the tell as to whether this market rally holds up or not will be the action of recent breakouts. As members know, I do not believe in breakouts as an initial entry signal – I am generally looking for earlier entries down in the base, and sometimes off the lows as is the case with an undercut & rally (U&R) log set-up. In my last report I covered four similar breakouts in previously busted leaders following their earnings reports.

The thing to keep in mind here is that all these breakouts were brought about by earnings reports. In the old days, a follow-through day would see a number of breakouts, but they were not the product of earnings surprises. They just happened as an expression of the health of the market as it flashed a follow-through day, with all cylinders firing.

If you review my Wednesday discussion of these four breakouts that occurred on the follow-through day, Twilio (TWLO), Tableau Software (DATA), Etsy (ETSY), and Planet Fitness (PLNT) you will note that these were all actionable buyable gap-ups (BGUs) on Wednesday well before they broke out. The trick is in determining as early in the day as possible whether these are buyable gap-ups or shortable gap-ups, because we’ve seen both throughout earnings season.

Let’s start with Twilio (TWLO) which was certainly a BGU on Wednesday before turning into an LSA-Method short-sale on Thursday. Yes, it became a short, and based on a very simple rule: Jesse Livermore’s Century Mark Rule in Reverse. Here we can see the stock push right up to the $100 Century Mark early in the day on Thursday and then promptly reverse off the highs to close negative on above-average volume.

It continued slightly lower on Friday during the day, but finally stabilized right around the new-high breakout point just below $90, closing at 92.23. Notice how a nimble trader, recognizing how the pattern would work out based on first the BGU and then the Century Mark failure, could have treated this as a long first and then a short. Certainly, the short near the $100 Century Mark was good for 8-9% of downside to the $90 price level.

Overall, Friday’s action looks like another stalling day, and this brings up the possibility of a potential breakout failure. The flip-side of this is that the pullback into the breakout point technically brings it into a lower-risk entry point, although I don’t consider it optimal. A pullback closer to the intraday low of Wednesday’s BGU price range would be optimal but would also set up an opportunistic short-sale swing-trade if the stock breaks below the 88.88 new-high breakout point. Play it as it lies.

 

GR111118-TWLO

 

Tableau Software (DATA) was an interesting BGU as I discussed in Wednesday’s report given that most, if not all, of the daily price move on the BGU occurred within the first ten minutes of the trading day! Talk about a high time-value trade. Even more interesting is that the stock turned into another very high time-value trade on the short side on Thursday and Friday as the breakout failed and the stock gave up all its Wednesday gains.

Speaking for myself, I stalk these types of breakouts as potential short-sale swing-trades. The reality is that every one of these provided some tradeable downside on the final two days of the trading week after BGU breakouts on Wednesday. Imagine that! Note that DATA tested and held the intraday low of Wednesday’s BGU move at 112.54, closing Friday at 114.11.

Technically, while the breakout has failed, the BGU remains in force, using the 112.54 low as a selling guide. More importantly, note that lingering too long on the long side would have resulted in one giving up all their Wednesday gains. That’s often the nature of this market, and those who advocate buying breakouts with the idea that a strong, intermediate trend is about to develop are probably asking for too much.

 

GR111118-DATA

 

Etsy (ETSY) was another BGU on Wednesday, resulting in a new-high breakout on Thursday. That probably brings in the late buyers who react to the tenets of Technical Analysis 101 and buy into the breakout. They were briefly rewarded on Friday as the stock pushed slightly higher before reversing to the downside.

I played ETSY as a short-sale on Friday, hitting on the MACD stretch on the 620-intraday chart early in the day as it pushed above the $55 price level. Members can view my Twitter page from Friday where I posted the intraday charts to get an idea of how this works. It then rolled over and posted an intraday low of 51.70 before stabilizing to close at 52.01. Another day, another short scalp.

In this position, the more orthodox approach would be to view this as a pullback to the prior breakout point, putting it in a lower-risk entry position. In my view, however, the best entry position occurred near the open on Wednesday as the stock gapped above the 50-dma and then proceeded higher from there. Now you’re a bit in what I would call no-man’s land based on the straight-up-from-the-bottom breakout.

From here, I would not be surprised to see a retest of the 50-dma. How that plays out, however, remains to be seen. But with ETSY trading at about 72 times next year’s earnings estimate, it may be vulnerable to PE-compression in a rising interest-rate environment. We might also note that DATA sells at 70 times next year’s earnings, which does the same for that stock, but perhaps not as much as TWLO selling at 576 times next year’s estimates.

 

GR111118-ETSY

 

Planet Fitness (PLNT) sells at 39 times next year’s earnings estimates, so is perhaps less vulnerable to a PE-contraction (or PE-compression, which I think sounds more sophisticated! 😉). After a buyable gap-up on Wednesday it churned its way to a new closing high on Thursday before dipping back below the new-high breakout point on Friday. Volume declined to below average, which is somewhat constructive.

Nevertheless, I would not view PLNT as buyable here at the top of the base. The stock broke out from a position below its 50-dma in straight-up-from-the-bottom fashion. Thus, it is vulnerable to a pullback closer to the Wednesday low at 51.69 and/or the 50-dma. Another interesting thing here is that the pattern looks like a base-under-base formation, which is not part of the O’Neil vernacular, which looks more for a base-on-base formation as being indicative of a stock that is trying to move higher during a market correction.

In this case, PLNT was going sideways after a prior failed breakout, but then broke out from a base that was lower than the base from which it previously broke out! Thus, a new pattern for this market: a base-under-base! This is entirely at odds with the alleged logic of a base-on-base pattern, which supposedly indicates a stock holding its ground during a correction that is coiling for a strong breakout.

In this case, the base-under-base looks like what would happen if you hold an inflated ball under water in your backyard pool and then let go. It goes popping back up to the surface, often with enough velocity to take it up into the air. In my view, all of this points to the pointlessness of trying to label bases as this or that with the idea of generating some sort of predictive value.

 

GR111118-PLNT

 

You might have also noticed that TWLO, DATA, and ETSY might also qualify as base-under-base formations. But, in my view, they may actually work out as double-tops, and TWLO was perhaps the most concrete in terms of determining a potential failure and reversal near the $100 Century Mark based on Livermore’s Century Mark Rule in Reverse. Keep an eye on these stocks, since they represent the first breakouts occurring on or after a follow-through day.

According to O’Neil theory, these would be your best leaders in any bold new market rally phase. Therefore, if this rally is for real, they should work as such. But if they just turn out to be double-tops or shortable breakouts based on my LSA-Method, then the market rally will likely not hold up. Meanwhile, other busted former leaders haven’t fared so well over the past two days.

Square (SQ) turned into a shortable gap-down on Thursday after disappointing on earnings after the close on Wednesday. The move into the 50-dma on Wednesday, which occurred on the follow-through day, simply ended up forming the peak of a second right shoulder in a fractal head and shoulders pattern.

Note how SQ pushed below the Monday low on an intraday basis before closing just above it on Friday. This might trigger a minor U&R move back up toward the 10-dma or 20-dema, which might bring this into a more optimal short-sale zone. The stock sells at 99 times next year’s earnings estimates, which still makes it vulnerable to a continued PE-compression.

 

GR111118-SQ

 

Roku (ROKU) also reported earnings after the close on Wednesday, and I noted in my Wednesday report that members should watch for actionable set-ups including shortable gap-downs (SGD) in both stocks on Thursday. Both posted SGDs and have since continued lower, with ROKU getting battered the most.

ROKU sliced right through the 200-dma on Thursday, continuing lower on Friday. I’ve posted a longer-term chart showing the entire 50%-deep cup-with-handle formation from which it broke out in August, picking up about another 50% of upside from there. Remember, however, that we were looking at the stock as a buy at around $35 back in May as it set-up in a roundabout type of formation, flashing pocket pivots and voodoo pullbacks along the 50-dma.

That’s how I like to start entering stocks, rather than chasing breakouts. In ROKU’s case, the breakout did work out well, but it worked out even better as an add point rather than a first entry. Those thinking that ROKU was set for a massive upside move were soon disappointed, as the stock became an LSA-Method short-sale on the breach of the 20-dema in early October, as I discussed in my reports at the time. A secondary short-sale entry occurred about two weeks later, on a final rally back up into the 50-dma.

You might also notice a head-and-shoulders formation with ROKU just busting below the neckline on Thursday. Overall, this is a great example of a roundabout long set-up, base breakout, and then complete failure on an LSA-Method short-sale entry. On the way down, additional short-sale entries and set-ups occurred on a rally into the 50-dma and then Thursday’s shortable gap-down.

 

GR111118-ROKU

 

CyberArk Software (CYBR) illustrates another variation on the whole gap-up phenomenon since it played out as a shortable gap-up on Thursday. This is what I’ve referred to in the past as a slider where the stock gaps up and posts an intraday high before sliding all the way to the downside and closing near the lows of the day.

If one was alert to this, then shorting early in the day would have worked out well. In this position, the stock looks like it’s on the verge of a breakout failure on another one of these base-under-base breakout moves that have occurred in conjunction with the alleged market follow-through.

 

GR111118-CYBR

 

CYBR’s failure to hold up on a BGU move on Thursday weighed on its cousin, Fortinet (FTNT). The stock initially gapped up in sympathy to CYBR but ran right into its 20-dema before reversing back to the lows of the daily trading range. Alert short-sellers could have hit the stock right at the 20-dema, and it then moved lower on Friday, breaking below the prior 76.02 low of late October.

That killed Wednesday’s U&R attempt, and the stock is now looking like it is going to test the neckline of its fractal head-and-shoulders formation. Note that the move into the 20-dema on Thursday formed the peak of a third right shoulder in the H&S pattern. The stock then pushed lower on Friday as selling volume increased.

FTNT, along with AAPL and NFLX, illustrates how U&R long set-ups that appeared on Wednesday in conjunction with the follow-through day are not holding up. This is unusual for this market, since these types of set-ups have worked very well when the market has turned. Not so this time around, and I must wonder whether this is telling us something about the future fate of this current rally off last week’s lows.

 

GR111118-FTNT

 

Cannabis names gave up on their nascent moves, with Aurora Cannabis (ACB) failing to hold the 20-dema after posting a pocket pivot at the line on Wednesday. The pullback, however, doesn’t look entirely out of whack considering that the initial long entry occurred on the prior U&R long set-up the prior week. This does put it in a lower-risk entry position using the 10-dma as a relatively tight selling guide.

 

GR111118-ACB

 

Cronos (CRON) also failed to hold its pocket pivot at the 20-dema from Wednesday but is now heading back toward the origination point of Tuesday’s pocket pivot at the 10-dma. Volume dried up in the extreme to -72% below average. Thus, we might watch for a test of the 10-dma as a potential lower-risk entry point if volume continues to dry up.

It’s important to remember that both ACB and CRON began their upside moves nearly two weeks ago on U&R moves. Over the past week, they became extended from those original entries, so that the current pullbacks look relatively normal within the context of the overall moves from the lows. Thus, I think these are both still worth watching as they edge back to the downside here.

 

GR111118-CRON

 

Twitter (TWTR) remains in a buyable position along the 200-dma as volume dried up to -36% below-average on Friday. The pullback seemed relatively well-contained given how badly the NASDAQ was getting hit. Thus, this is buyable using the 200-dma as a tight selling guide.

 

GR111118-TWTR

 

Viomi Technology (VIOT) is looking pretty juicy here as it sits nice and tight right at its 20-dema. Volume dried up to -93% below average on Friday, but on an adjusted basis that accounts for the big volume spikes on its first two days of trading, volume was more like 75% or so below average. Either way, that’s a very sharp decrease in volume, and qualifies as a voodoo pullback to the 20-dema, using the 20-dema as a tight selling guide.

 

GR111118-VIOT

 

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 (the magenta line), 20-day exponential (the green line), 50-day simple (the blue line) and 200-day simple moving average (the red line). On rare occasions, I will also employ a 65-day exponential moving average (thin black line). In all cases I will mostly use the shorthand version of “10-dma,” “50-dma,” etc.

The evidence over the past 2-3 days around Wednesday’s so-called follow-through day reveals a mixed market. Both long and short set-ups have shown up, with some of the short-sale set-ups coming as a result of Wednesday’s sharp market rally. With the Fed confirming on Thursday that they would remain on their current trajectory of interest rate increases, Wednesday’s momentum reversed in the indexes, and most notably in the NASDAQ, which is a much higher-PE realm.

In my view, the action of individual stocks after Wednesday’s sharp rally is more typical of a bifurcated, trendless market where we see set-ups on both side of the market. Generally, these turn out to be short-term swing-trading, even day-trading affairs, and not much more. But some busted leaders keep plunging lower, and there isn’t much that I would consider compellingly fresh areas of leadership.

Obviously, if one sees a long set-up in real-time, one can act as appropriate. But keeping risk to a minimum will be critical given the uneven state of the market, despite the so-called follow-through day. But as I’ve already indicated many times before, follow-through days to me are merely incidental, and not central to the process of identifying turning points and potential long set-ups individual stocks.

It would be nice if there was such a thing as flipping the all-clear switch and giving everybody a big green light to just start piling into stocks. But the immediate leadership in terms of fresh breakouts is questionable, in my view. Thus, I see no reason to rush things. I also see no reason to take a rigidly bullish or bearish view, since it is clear from the objective real-time action that one can take trades on either side and execute those trade successfully.

So, if you’re an investor in search of the start of a more substantial intermediate trend, you can certainly buy long set-ups, including breakouts if you are oriented toward such things. Whether they are successful with respect to producing meaningful and substantial upside remains an open question. But there is never any reward without risk, so adhering to the tightest selling guides possible hopefully keeps things in control.

For now, pending further evidence, I remain focused on playing the set-ups at hand, long or short. At the same time, I want to avoid getting locked into a rigidly bullish or bearish posture. This will enable one to see and act upon the real-time evidence as it emerges rather than trying to act on what one things the market should be doing. In short, play it as it lies.

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 a position in ACB, 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. ©2008-2019 Gil Morales & Company, LLC. All rights reserved.