Netflix, Inc. (NFLX) ceded leadership of the FAANG complex in July, topping out and gapping down following a poorly received second quarter earnings report. Selling pressure eased in August, but the subsequent bounce has failed to fill the gap while weekly relative strength cycles have hit overbought levels. This potent combination raises the odds for a secondary downturn that rewards opportune short sales.
The company sharply lowered third quarter new subscriber guidance during the July confessional while talking down Wall Street earnings and revenue estimates. A wave of downgrades followed the news, but the usual suspects have come to the rescue in the past two months, talking up 2019 performance ahead of the Oct. 16 third quarter report. Even so, potential investors are acting cautiously, generating few technical signs of committed buying interest.
Earnings are less than two weeks away, which may dissuade risk-conscious short sellers from taking direct equity exposure. These reports have triggered high-percentage rallies and sell-offs in past quarters, inducing intense pain when caught on the wrong side of the equation. For that reason, experienced market players prefer well-constructed options plays, establishing downside risk to the penny before metrics hit the news wires. (See also: Goldman: Wall Street is Underestimating Netflix.)
NFLX Long-Term Chart (2009 – 2018)
The stock broke out above five-year resistance at a split-adjusted $5.50 in 2009, entering a powerful trend advance that topped out in the mid-$40s in July 2011. It got crushed in the next year, dropping into the single digits before finding support within two points of the multiyear breakout. A bounce completed a round trip into the prior high in September 2013, generating a quick rally into the $60s before easing into a sideways pattern on top of new support.
It cleared range resistance in 2015 and entered a stair-step uptrend that caught a momentum wave at the start of 2017. The stock price more than tripled into June 2018, posting an all-time high at $423.21 and pulling back in a minor retracement. A July breakout attempt then failed, completing a double top breakdown during the post-earnings sell gap. The monthly stochastics oscillator rolled into a sell cycle at the time and continues to predict lower prices. (For more, see: Why Credit Suisse Sees NFLX Climbing to $470.)
NFLX Short-Term Chart (2017 – 2018)
The decline into August 2018 found support at the .382 Fibonacci retracement of the December into July rally leg, while the subsequent bounce has stalled at the .618 retracement of the July into August sell-off leg, which is aligned with the bottom of the unfilled gap. The stock mounted the 50-day exponential moving average (EMA) about a week ago and is now sandwiched between support and resistance in a narrow range pattern.
Price action is now stuck between a rock and a hard place, signaling a major decision point for bulls and bears. It’s a bilateral scenario in which a buying spike will attempt to fill the gap and reach the .786 retracement level, or the rally will end with a breakdown through the moving average. Stochastics relative strength cycles favor the downside, with bearish monthly and overbought weekly readings predicting that sellers will take control in coming weeks.
The on-balance volume (OBV) accumulation-distribution indicator lends support to the bearish thesis, posting an all-time high in June and turning sharply lower in reaction to heavy July selling volume. It bottomed with price in August but has diverged since that time, stalling two weeks later and dropping into a sideways oscillation that indicates little or no buying enthusiasm ahead of third quarter earnings. (See also: Buy Netflix on Massive India Opportunity: Guggenheim.)
The Bottom Line
Netflix could sell off here and test the summer low near $310, which has now aligned with the 200-day EMA. That would translate into a 20% decline, rewarding opportune short sales. (For additional reading, check out: Netflix: 7 Secrets You Didn’t Know.)
<Disclosure: The author held no positions in the aforementioned securities at the time of publication.>
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