How to Avoid Gambling in the Markets Plus My Bull and Bear Stock Predictions (and More)
I titled last week's weekly Report “The GameStop Suffocation of the Financial Markets” and made a point of discussing the fact there are basically no shortcuts to success in this business.
Now of course we've all been fascinated with the rollercoaster ride in GameStop. GME started out around $6 - $9 and rose to nearly $500 in the pre-market sessions at some point. That’s a wild ride!
But as I was saying last week, these parabolic moves always end in tears.
Look at how GME peaked with a clear double top price pattern. It subsequently dropped to $60 by the end of the week.
What if you bought near the top? Or anywhere in that highly speculative bubble? You might not ever get your money back by this point.
All those young traders on Robinhood got caught up in this thing and now they’re substantially underwater. Trading on emotions (which is what most of these traders did) and effectively taking shortcuts inevitably ends in disaster.
So how exactly do you know when to jump aboard? How do you know when to jump off?
That's really what I try and do week after week here at The Pattern Trader. Getting in and out always comes down to price, because price is the information - “the news” – you can rely on. Not rumors or emotions or anything like that.
Let’s illustrate that with a real world example I’m involved with right now.
Last week I highly recommended taking a long position in Lyft Inc (LYFT):
That was before LYFT closed at a multi-year high just above the $53 area.
I knew to get into LYFT when it was around $45 because of a key price pattern. I was looking at the very robust double bottom around the $15 -$20 area. For most of LYFT’s existence, it’s been tracing out a bottom.
As you might expect, the word “bottom” suggests this only has one way to go: higher. So when LYFT cleared the neckline of that double bottom, this confirmed the stock was ready to “lift” off (no pun intended).
After that initial breakout, the stock encountered a bit of resistance and then settled back. Typically this is what happens after a breakout: the price retreats and retests the level at or near the breakout area. Once that retest is successful, it’s a very strong indicator that we’ll see much higher prices soon.
Following that retest, I not only bought the stock but I bought call options about to expire on Friday. I bought the $46 calls and the $47 calls while the stock was around $44.50-$45. These were therefore “out of the money” calls because they had no intrinsic value at the time (the strike price was higher than the stock price).
I paid about a dollar for each of these very speculative options. (I don't do this very often unless I feel good about an impending move because not only do you need to be right about the price direction and magnitude, but also you need to be right about the timing.)
But because of the giant double bottom in LYFT acting as the governing price pattern, I was confident that price was much more likely to go up than down – and soon.
The size of that double bottom is such that we could see an uptrend in LYFT for many days, weeks, months, and possibly years going forward.
So I do believe that this is just the beginning.
Anyway, I bought out of the money calls as a short-term bet to add to my longer-term bet on the underlying shares.
LYFT went through my strike price and suddenly I was “in the money”. My options were moving dollar for dollar with the stock. This gave me incredible leverage as the call options I bought for about a dollar were suddenly worth $6 (the $47 calls) and $7 (the $46 calls). That’s where I sold them.
I still have the underlying stock and I’ll look at the next series of call options after LYFT announces their earnings on Tuesday, February 9th. There's huge volatility around earnings calls, and I anticipate that volatility will inevitably be favorable even if LYFT initially falls back.
To my mind, I would any pullback in LYFT is a buying opportunity because I feel the inevitable trajectory of the stock will be higher.
Another stock that’s caught my imagination recently is Kratos Defense & Security Solutions (KTOS):
This company sells drones to the US military and certain other cybersecurity products. But I’m primarily interested in the price action as this stock has moved swiftly from $5 to its present level around $29.
So it's had a huge move already. However, based on the underlying price patterns, it looks like there's a huge move still to come.
The patterns I’m looking at include an asymmetric double bottom acting as the head of an inverted head and shoulders pattern. (An asymmetric double bottom is when one bottom is higher or lower than the other.)
Again, with the word bottom in this pattern, the implication is that KTOS will keep going higher – especially since the stock has broken out over the neckline.
What’s more, last week KTOS traced out a very healthy bullish key reversal. (That’s one where price dropped to a new low early in the week before reversing to close at the high of the week.)
The combination of a very bullish looking double bottom / inverted head and shoulders price pattern combined with the very bullish key reversal price action suggests KTOS is going higher.
Now I need to disclose that I’m long KTOS call options expiring in March with a $32.50 strike price. Again, these are out of the money calls for which I paid about a dollar. That means KTOS has to go to $33.50 or better just for me to break even on them.
But I've got about six weeks before those options expire, and I think it's a good bet to take because the underlying chart patterns and price action in KTOS look so promising.
That’s not to say that all stocks look like they’re going up. In fact, I don’t feel we have a stock market right now. Instead it's a market of stocks. T
here are some shares like LYFT and KTOS which look like they're going higher. But some stocks look like they're going lower.
There've been a recent spate of the IPOs that are starting to trace out bearish price patterns.
For example, the stock of Lemonade Inc (LMND) shows a prominent double top around the $175 price level.
Right now LMND is hanging at or near the neckline around $140. If the price drops below that level, there looks to be some room on the downside for LMND.
I'm also looking at Snowflake (SNOW) which is showing an unconventional double top price pattern. Just like the asymmetrical double bottom we saw in KTOS, I believe we have an asymmetrical double top in SNOW:
SNOW is sitting on prices right around the neckline of that double top. Any penetration below the $300 price level should take the stock lower.
Now I'm looking at the weekly chart of DoorDash (DASH):
This was also a recent initial public offering (IPO) and appears to be tracing out a bearish head and shoulders price pattern. The price is sitting right on the neckline at $180 and any penetration below this should take prices lower -- perhaps much lower.
I feel particularly bearish here because the head of the head and shoulders is a very long and ominous key reversal. The price spiked to an all-time high and then closed almost at the low.
So once again, instead of getting caught on wild rides like GameStop and not knowing what you're getting into, instead sit back and review patterns. Let the market tell you where it wants to go.
That's how I'm able to hop aboard and capture monster moves and companies like LYFT, KTOS and others.
Incidentally, the same Reddit crew that tried to push up GameStop also tried the same trick with the silver market. They thought they could create a short squeeze in silver.
It wasn’t very successful.
As you can see from the chart below, silver went over $30 early in the week, but crashed before the weekend and is now trading under $27. Here’s the chart of XAGUSD (spot silver):
XAGUSD traced out a nasty key reversal where it made a new high and then closed on the low of the week. That also created what appears to be a meaningful double top at the $30 resistance level.
I'm going to be especially alert about the price action in silver and whether this really does represent a top and leads to much lower prices. Otherwise silver needs to grab a foothold and consolidate around current levels.
But it doesn’t look good at the moment. That key reversal is very negative for the market and once again, it shows why you can’t simply go with the crowd. You can’t go in blindly with your emotions. You have to be incredibly disciplined to win in this game.
Otherwise you're going to lose your shirt.
Now here’s XAUUSD (spot gold):
At the top, I was saying that it looked likely to be the end of gold’s extended rally, at least for the short term. So far I’ve been correct.
I expected gold’s price to drop because of the huge explosion in volatility that occurred where gold was moving $100 a week at the peak.
Look at how small the bars were before the explosion. They were more contained and much more orderly.
But once volatility starts to expand, it often indicates that emotional retail elements are starting to come into the market. That typically precedes a turn or at least a lengthy consolidation, which is exactly what we've seen in gold.
Gold has formed a neutral symmetrical triangle and looks ready to test the lower end of it. I anticipate gold will continue to break lower.
In fact, I feel gold is trading within an ascending broadening formation – an inherently bearish price pattern. It suggests that if gold were to break the lower side the pattern at the $1,650 - $1,700 level, gold could retreat all the way back to where it started at around $1,200.
Do I think that’s likely? No. But it’s possible.
To illustrate why, I'll show you a couple other symmetrical ascending broadening price patterns and how they played out.
Here’s GBPAUD (the British pound versus the Australian dollar) and its ascending broadening formation:
Once the low end of the price pattern was triggered, prices collapsed. Gold might do that too, but it’s too early to tell.
Remember, it's very important to not look at these patterns in a static manner as if we were examining a textbook. Look at these patterns and watch at how the market reacts within the patterns and conforms to them (or not).
That’s the nuance and it’s what has enabled me to be incredibly profitable in contrast to many years where I struggled because I took these patterns literally and got into trouble. Ultimately the market is always right.
Always defer to the market action within the context of the pattern.
Now I'm going to show you another way an ascending broadening price pattern played out in the chart of the NASDAQ:
As you probably know, the NASDAQ is the stock index that represents the tech sector in the United States.
Price patterns are timeless and they recur in many different trading instruments. But they may have different permutations or implications as they play out.
Here we see that the NASDAQ’s ascending broadening formation was the impetus for a huge move higher after hitting the lower edge of that pattern.
GBPAUD went in the opposite direction, and that’s the difference when it comes to how these patterns play out.
The NASDAQ has kept powering to new all-time highs with a series of bullish key reversals that pointed in the direction this market wanted to take. We’re seeing a melt up and an increase in volatility that we saw with gold.
In fact, if I see three long blue bars in a row (just like the one we saw last week), that would suggest we're close to a peak and a meaningful pullback in the NASDAQ. (This is the scenario that happened with gold and also silver – multiple long bars in a row, indicating very high volatility).
But we're not at that juncture yet.
All good things must come to an end, but now there’s no pattern that suggests a turn is at hand. I would change my mind if the NASDAQ traces out a series of bearish key reversals. That would signify the start of a roll over.
Until then, this market is too dangerous to short.
Let’s look at some FX pairs now.
One of the pairs that I've made a lot of money on is USDJPY (the US dollar versus the Japanese yen):
USDJPY has been trading within the confines of a descending sawtooth trading pattern where each high is lower than the one before.
And despite the fact that I've been really bearish on this pair, I’ve been cautioning members about a trap at the support line of the triangle. Every time USDJPY gets to the 102 – 103 area, there’s a huge amount of support.
The question is how much longer that support will remain.
I still believe the implications of this chart are bearish and eventually USDJPY should drop. But in the meantime, this pair could thrust up one more time to the trendline of the triangle to 107 – 109. If it does get that high, I’d expect USDJPY to revert back to the dominant downtrend.
So there’s no rush to take a position here yet. Just keep an eye on the price action for now.
For comparison, here’s the monthly chart of EURJPY (the Euro versus the Japanese yen):
I’m analyzing the monthly chart because I want to give you a global view of what's been happening in this pair.
EURJPY continues to vex me as to the direction of its next move, which is why I’m zooming out to the monthly view to get the bigger picture.
You can see that EURJPY is trading in the context of a symmetrical triangle and that recent momentum might carry it as far as perhaps the 129 – 130 level. At that point, it’s likely to bump into some major resistance.
There’s also the presence of what I feel are EURJPY’s dominant patterns within the long-term symmetrical triangle. Those patterns include a head and shoulders and a double top.
Notwithstanding the recent rally, I feel the upper edge of that triangle is where we’ll see some kind of trap sprung in the not-too-distant future. Already EURJPY is finding it harder to keep moving up.
In the meantime, several other yen pairs are starting to show robust price action, suggesting there’s still more room to run on the upside. Those pairs include AUDJPY (the Australian dollar versus Japanese yen) and GBPJPY (British pound versus Japanese yen).
I also believe the dollar will continue to go lower.
That brings us to AUDUSD (the Australian dollar versus the US dollar) and the implication that it’s likely to go higher on USD weakness.
That’s due to the large, inverted head and shoulders we see here. This is the same pattern we saw with KTOS with the same bullish implications. (Once we see bullish price patterns, it sets the direction for that instrument over the following days, weeks, and possibly months and years.)
AUDUSD is especially bullish as the right shoulder is higher than the left. This creates a sloping neckline. So regardless of any short-term drop within the confines of the pennant/channel I’ve drawn above, I feel AUDUSD will keep going higher in the long run.
Most recently, AUDUSD also traced out a bullish key reversal. This suggests the drawdown might already be over. A breakout above the pennant/channel would be especially bullish.
Use any selloffs as opportunities to consolidate long-term long positions in AUDUSD.
I'll finish off by looking at GBPUSD (the British pound versus the us dollar):
Note the series of basing patterns that suggest the long-term price is headed higher: primarily the Eve and Adam double bottom.
The Eve bottom is more rounded and consists of multiple pokes at the support area, while the Adam bottom is a spike consisting of just one bounce off the support area.
This is similar to what we see in LYFT and its double bottom. The stock rose to new multi-year highs after forming that pattern and we could see the same result here in GBPUSD.
GBPUSD has just broken above historic resistance which should now act as support at 1.35. There was also a bullish key reversal suggesting GBPUSD’s next move will be higher. GBPUSD is a buy on any weakness and you could also consider placing a buy stop above the recent highs.
And that’s it for the week!
I’m bullish on LYFT, KTOS and the NASDAQ and bearish on LMND, SNOW and DASH. Both silver and gold look more bearish than bullish at this time. I’m waiting for the upward momentum to fade out in USDJPY and EURJPY and I’m bullish on AUDUSD and GBPUSD.
I wish you a very healthy and prosperous trading week.
Mark "MarketOfStocks" Shawzin