SSS - Anticipating the Short-Side in a Market Uptrend: A Pre-Earnings Review of Possible Set-Ups

Published : November 2 2014 at 13:25 ET

More so than the long side of the market, short-selling requires the ability to anticipate set-ups as they evolve in real-time. Reacting to a well-entrenched market correction or downtrend after the market has already come down several percent by suddenly having the urge to get short everything is a common mistake among inexperienced short-sellers. In practice, a pro-active approach of maintaining awareness of possible short-sale set-ups in-the-making is best, even during a market uptrend. If the uptrend loses momentum, and a market correction ensues, even a normal, short-term correction, profitable short-sale set-ups can develop quickly. Thus it is better to be pro-active rather than re-active.

Lately we've been tracking the action in five formerly "hot" names that had strong upside earlier in the year and then topped in brutal fashion during the March-April general market correction: Yelp (YELP), Workday (WDAY), Tableau Software (DATA), Splunk (SPLK), and FireEye (FEYE). All of these stocks topped in March and formed the right sides of heads in large head and shoulders formations. After bottoming with the market in April/May, most of these names have been working up the right sides of large cup-like formations, in some cases forming right shoulders to the head they formed in March/April, such as YELP, shown below on a weekly chart. YELP previously announced earnings on October 23rd, and gapped down at that time from what can now be seen as the third right shoulder in a very large H&S extending back to March of 2013. Notice the wedging rallies in August and September that stalled out and formed the peaks of the first two right shoulders. The third right shoulder formed on a one-week reversal that found resistance right at the 10-week and 40-week moving averages. There is still potential for YELP to move further downward towards its neckline, with near-term upside resistance in the mid-60's. For the purposes of this discussion it serves as a "model" for what we might look for in the other four stocks in question that are scheduled to announced earnings in November.

YELP Weekly Chart

For example, WDAY is expected to announce earnings on November 26th, and it has managed to trundle higher since bottoming in early May, forming what appear to be two more possible right shoulders in an overall H&S extending back to September of 2013. Notice how WDAY has stalled out near the highs of the second left shoulder in the pattern around the 95 rice level. On Friday the stock gapped up and closed just above the 95 price level as it makes its highest-high since the May bottom. With earnings still three weeks away, this should be watched to see whether Friday's breakout attempt fails.

WDAY Weekly

DATA is expected to announce earnings this Wednesday, November 5th and it, like WDAY, has managed to wedge its way to higher-highs since bottoming in April. In early July it stalls out at the 40-week moving average but manages to breakout back above the 40-week line in September. A pullback from there holds the 10-week line, and the past three weeks have seen the stock move higher on a wedging rally. On a daily chart, not shown, we are also seeing higher-highs being made on lighter volume. This needs to be watched for some sort of shortable gap-down move after earnings, which could put it into play as an active short-sale target.

DATA Weekly

SPLK is expected to announce earnings on November 20th, so there is plenty of time for something to develop here. SPLK topped in a big-volume reversal week in late February, and actually completed a head and shoulders formation, breaking out through the neckline on the downside in early May. A rally then ensued as SPLK bottomed with the general market, stalling out at the prior neckline at around the 54-55 price level. Since then SPLK has managed to work its way higher, breaking out through the 40-week moving average over the past two weeks as volume has declined - a standard three-week wedging rally to higher-highs. Near-term a breakdown back through the 40-week/200-day moving averages would bring the stock back into play as a short-sale target.

SPLK Weekly

FEYE is expected to announce earnings this Tuesday, November 4th, and has been the weakest among these five early-2014 "hot" stocks that comprise our discussion. Since bottoming with the market in early May, FEYE has been "living" below its IPO base formed in the latter part of 2013. It has rallied on relatively light weekly volume right up into the upper end of its current downtrend price channel, as is outlined on the weekly chart, below. Based on the technical action, it would take a major earnings surprise to send the stock back above its 2013 IPO base. On the other hand, an unimpressive report could send the stock on a retest of its early October lows, representing a price move of over -30% from current price levels.

FEYE Weekly

As we can see, YELP began to break down before its earnings announcement, which was a major clue that occurred well ahead of the report. With the other four stocks in our discussion. the potential for their current rally attempts to be derailed on a poor earnings report is there, and often this can set up a shortable gap-down event. Alternatively, the alert reader will note that any of these stocks could also attempt to rally higher up the right side of their charts and form Punchbowl of Death (POD) type formations. If this turns out to be the case, then one can extrapolate a right-side POD rally into a tradable move on the long side, using bottom-fishing and roundabout pocket pivots as buy points but looking to sell as the stock approaches the left-side peak of the POD.

Obviously, the situation with all four of these stocks remains in flux, but an understanding of how they could play out as possible short-sale targets under different scenarios in real-time is part of the process of being pro-active on the short side rather than re-active and late to the party. Also, an understanding of how a broken-down stock might play out as either an H&S or a POD aids in the idea of exploiting further upside via a swing-trade on the long side as the stock continues up the right side of a potential POD formation.

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