Short-Sale Set Up - Review of McDonald's (MCD) and Facebook (FB)

Published : February 28 2016 at 19:25 ET

A week ago we put out Short-Sale Set-Up Reports on MCD and FB. The initial premise for doing so was that both stocks are de facto prior breakout failures that are rallying back up into potential areas of resistance. Obviously, the first sign of a potential late-stage base-failure or LSFB beginning to form is going to be a failed base breakout attempt.

MCD failed early in February after attempting to breakout from a slightly ascending type of base formation. The high-volume breach of the 50-day line brought the stock into play as a potential LSFB short-sale set-up. Since then it has chopped around the 50-day moving average in what appears to be a short bear flag. This remains in a shortable position, and we suggested using the 120 price level as a guide for a tight upsides top.

So far the stock hasn't pushed above the 120 level, but nor has it broken down in a clean downside breakout from the short bear flag. In our view, this will likely ONLY OCCUR if the general market fails. Therefore, timing a short-sale to coincide with such a potential general market failure will be key in turning this into a successful trade.

Facebook (FB) posted a trendline breakout and then a new-high breakout in early February, and like MCD immediately failed by breaching its 50-day moving average (as well as the prior breakout point) on very heavy selling volume. This action was the first sign of a potential LSFB short-sale set-up starting to form. After filling the gap from late January, the stock has since rallied back up through the 50-day moving average on declining upside volume.

At the time of our initial report, our premise for the SS Set-Up was based on the initial LSFB with the idea that a high-volume breach of the 50-day moving average would confirm a possible retest of the early February lows and the 200-day moving average. FB has been able to rally further above the 50-day line, but volume has remained light.

On Friday of this past week, the stock pushed up towards the new-high base breakout point around the 110 price level before reversing on light volume. As a big-stock leader, FB tends to be a market stock, and so has drifted higher as the market has pushed higher off of the mid-February lows. 

Given that MCD and FB remain two of the biggest big-stock leaders that are still within reasonable range of their prior 52-week highs (MCD is -6% from its 52-week high, FB is -8% from its 52-week high), we would expect that any substantial breakdown from here will likely have to coincide with a general market rally failure.

It is important to understand that a short-sale set-up formation is merely the first half of the equation when it comes to a potentially profitable short trade. Breakdowns in the patterns of individual stocks tend to coincide with general market breakdowns. One need only study our short-sale targets from last year, TSLA, AAPL, and NFLX on a comparison chart with the NASDAQ Composite Index, below, to understand how these tend to play out within the context of the general market action.

These three stocks have correlated quite closely to the NASDAQ's breakdown so far in 2016. FB and MCD do not. However, each new leg in a possible bear market will see new "waves" of leading stocks breaking down. Stocks that are less developed in their potential topping patterns will tend to eventually breakdown in subsequent market down legs. 

We can see this by comparing FSLR and AAPL to the NASDAQ top in October 2007. As the NASDAQ formed a first short leg down in the 2007-2009 bear market, AAPL continued to hold up until early 2008. At that point it topped and broke down, and this coincided perfectly with the NASDAQ's second bear market downleg. FSLR kept making higher highs well into May of 2008 before it finally topped and the completely blew apart in September 2008. This huge break coincided with the NASDAQ's third bear market down leg.

Our thesis for FB and MCD as potential short-sale targets rests on a similar outcome. If we are in a potential new bear market, and have seen the initial downside legs in this bear market, then we might expect to see stocks like FB and MCD eventually come apart in conjunction with later bear market downlegs in the general market. That is what we are watching for here with these two initial LSFB type set-ups. 

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