Arguably the hottest media stock of the past year, Netflix (Nasdaq: NFLX), has been in serious decline for the past five weeks. And by serious I mean it has shed nearly a quarter of its market capitalization since peaking in early August.
This has bargain hunters chomping at the bit. But a look at the chart tells us at its current "sale" price it is not cheap and could drop another 20% from here in a hurry.
In short, this is a stock for short-term bears that may present a good buying opportunity for long-term bulls in a few weeks.
Since this column focuses on trading, not long-term investing, let's take a look at the reasons why Netflix has a fork stuck in it.
The rather obvious technical pattern on the chart is the ubiquitous head-and-shoulders with its central high (head) flanked by two lower highs (shoulders) on each side. The bottom of the pattern is bound by the neckline, which connects the troughs between the peaks. Whether it is drawn flat or with a slight downward slope from left to right is not important.
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What is important is that Netflix closed below that neckline on Friday after the weak August jobs report. On Tuesday, when trading resumed after the long Labor Day weekend, it jumped with the rest of the market at the open on rumors that China would embark on a stimulus program.
However, unlike the Dow Jones Industrial Average, which went on to post a 390-point gain, Netflix found its daily high immediately and then sold off. Within minutes it gave up its gains, and by the close it was down nearly 4%.
In technical jargon, it was an intraday reversal to the downside and failure at the now-broken neckline. In other words, the initial euphoria wore off in a hurry as the bears grabbed the controls once again and the major trend to the downside reasserted itself.
Of course, in order for a head-and-shoulders pattern to form, prices necessarily must no longer be near their highs. A good deal of the decline is already in the past, but as I mentioned, there is plenty left for new bears to grab.
The downside target is the height of the pattern projected down from the breakdown point. On a linear scaled chart, that would be in the $72.50 area. However, I have found that projecting downside targets this way on stocks or indices that have seen very large price moves can result in levels that are too aggressive. For example, projecting a downside target in 2000 after the Internet bubble popped would have given the Nasdaq a negative number target. Clearly, that would be wrong.