What GameStop Means for the Markets Plus My Favorite Trades Right Now
Before I dig into this week's market action, I want to shout out to the hundreds of supporters who sent well wishes for my recovery after hamstring surgery last week.
So far all is well and I'm back in the saddle, albeit with some pain as I need to stand up instead of sitting down. So thank you to everyone for those hundreds of emails from around the world. It was very touching.
You know, when I started The Pattern Trader, I had no idea what was going to happen, but I've come to discover I have a second family consisting of literally thousands of people around the world. This is much more gratifying than the balances that go up and down in my trading account each day. Again, a special thank you to everyone!
Now let’s get into this week’s analysis.
I'm going to start this Report a bit differently because the market’s collective imagination has been seized by a company called GameStop. This business was not in great financial shape and was literally shuttering. Thousands of its outlets in malls around the country were slowly dying because those malls are closed.
Yet the company’s stock rose from about $9 a month ago to over $500 last week after a forum on Reddit called WallStreetBets helped spark a short squeeze in the stock (I’ll explain what that is shortly).
GameStop is currently sitting at a $22 billion market cap as I write this, although by now I’m sure the price is probably quite different due to the extreme volatility in the stock price.
I’m highlighting this event because it could have a ripple effect across multiple financial markets in terms of unpredictability, uncertainty, and volatility. (In a moment, I'm going to show you a different way to play volatility.)
That’s because volatility was already picking up across the board thanks to the recent spate of IPOs from Airbnb, DoorDash and the like. These companies have exploded to tens of billions of dollars in market cap overnight via Special Purpose Acquisition Companies (SPACs).
And now this ramp up of obscure dinosaur GameStop into something with over $22 billion in market cap is starting to raise some questions about the integrity of the financial marketplace.
I'm sure there will be a host of inquiries and committees over this. I'm not sure how they're going to regulate it, but I'm quite certain they're going to overregulate in the wrong place, as usual.
I think we need more transparency -- especially in the hedge fund sector -- because nobody knows what these hedge funds are doing. I think this little company and the Reddit forum exposed some of the obscure Internal machinations of these hedge funds.
Also the stockbrokers reached in to stop retail traders from trading last week even as hedge funds were allowed to keep trading. As you can imagine, this raises a lot of philosophical issues and structural market problems.
Now how did this occur?
Short selling is about borrowing a stock from somebody else to sell it into the market. Sometimes your broker will have that stock in his inventory. But more often than not, you have to ask the broker to borrow it from somebody so you can short it.
Either way, the short seller hopes to profit by covering the short at a lower price and then returning the shares to the original shareholder.
But what happened with GameStop was that the collective short position aggregated 138% of the outstanding stock in the company. How did that happen?
Brokers are able to lend this stock over and over. When they carry it in their inventory, it appears they can lend it to an unlimited number of short sellers.
Traders on a Reddit forum understood that the only way out for the short sellers was for them to cover (a.k.a. buy in) their positions at a much higher price because of the over-extension of borrowed shares. So they ganged up on this company that had a 138% short position. It was an elegant form of collusion.
I'm not sure how you would regulate that because it really does come under free speech.
Anyway, we all saw the collective unwinding of those short positions and the ensuing insanity.
I'm sure will eventually end in tears because this company has limited business prospects at best right now.
You would think that the $22 billion valuation would send this stock back into some realm of reality, but what it's exposed is how a struggling company could rise to $22 billion market cap. I think that’s going to rattle a lot of people who have their pensions and retirement funds in a market with this inherent structural question mark about it.
Again, I'm discussing it now because it could spill over into uncertainty and volatility in the next few weeks to come.
So question is, what do you do? How do you play it? And do you play it at all?
The safe bet is to stand aside and let some of this subside.
The disconnect between the value and the market price of GameStop extends to the same disconnect that we see in the NASDAQ where, since the height of the pandemic last March, we've seen the NASDAQ soar to unprecedented heights.
All this while millions of people are losing their businesses and losing their jobs.
Last week was the first time we saw a potential “tiring” of this huge parabolic upmove.
That took the form of a large bearish key reversal where earlier in the week the NASDAQ made a new high, but by the end of the week the price closed on the low. I call such bars key reversals because
very often they point in the direction the market wants to go.
But as I've cautioned in the past, you can't play these key reversals in a vacuum. They have to be preceded by some kind of trend or pattern. The NASDAQ isn’t showing that yet.
It could be at the beginning of a pattern, of course. But we’ll need to see much more extensive market topping behavior before we can short with any kind of confidence.
I’ve highlighted a decline in the NASDAQ where there’s a key reversal as part of a double top pattern. There was extensive follow-through there. That was a short you could take with some confidence.
Then again, there was another key reversal without such a double top or other identifiable pattern. That was not a short with a reasonable risk/reward ratio, in my opinion.
Right now it’s an open question as to which of those two kinds of top (if any) we’re about to see.
But there’s absolutely no doubt in my mind that the earlier top was much, much safer to short because there was a price pattern and price action supporting a short sale.
Last week could precipitate a sell off, as shown in the NASDAQ’s history.
But I prefer to wait for a pattern that will translate to a top and then a sell off with a much better risk/reward ratio. Right now the market is likely to move on pure emotions which are highly untrustworthy for sensible trading.
Let the NASDAQ shake out a bit and then let’s see if we have a tradeable top (or not).
Remember, you don’t win in this game by always focusing on how much money you’re looking to make in a position. Instead look to enter positions where you can understand your risk.
That’s why I’m reviewing the chart for LYFT (Lyft Company) here, which is a much better way to play market volatility than the NASDAQ or GameStop right now:
This chart shows a very large double bottom with a neckline at $40. That price level should act as a foundation for this stock to launch from. Especially when there’s a case for a mini head and shoulders that might be enough to drop the stock to $40.
However, we might not need to wait to see $40 though. That’s because there’s recently been a bullish key reversal which could offer near-term support for a rapid rise.
So which will it be? No one knows including me.
The idea is to look at market structure, draw your patterns and then see how the market responds within the structure. So right now we have a bullish case (stronger) and a bearish case too (weaker).
Let’s see how the market responds. If there’s a selloff, perhaps LYFT is about to roll over to the $40 area and I'll revisit it at that point.
But if LYFT instead grabs a foothold at current levels, this could be a very interesting opportunity.
That’s because it all comes down to risk and reward. If you enter a trade here, you can understand your risk by placing a stop loss under recent lows. The upside would be multiples above the current price.
I can justify doing those kinds of trades all day long even if they don't work out one particular time. That’s because the ones that win “take care of business” and more than make up for the losers.
One way to enter LYFT is to look at the downtrend line that’s tracking the mini head and shoulders and put a buy stop around $46 or $47. If it clears that area, that huge double bottom is likely to act as a foundation for a large upside move.
I'm actually in long positions in LYFT right now as I watch the price action here.
And that’s all I have to say about stocks this week. Onto currencies …
In contrast to all the stock market excitement recently, the FX markets have been quite boring.
Here’s the USDI (US Dollar Index) which measures the US dollar against a half dozen of world’s major and most liquid currencies.
USDI has been fairly range-bound for the last few weeks along a major support line.
However, I expect this support to be taken out eventually. In the short term, we could very well see a consolidation (and even a small rise) that could last a few weeks before a decisive move.
I’m basing my belief in the lower trajectory scenario for USDI on the bearish price patterns established across multiple timeframes including monthly, weekly, and even very long-term price charts. All of them indicate there’s nowhere for the dollar to go but down over time.
At this weekly level, the most important pattern is the head and shoulders with a sloping neckline as you can see above.
The implications of that sloping neckline are not just bearish, but very bearish – much more so than a flat neckline.
USDI should drop very quickly at some point. So I would not be lulled into becoming a dollar bull during what could be sideways or even short-term bullish price action.
I would look for any rallies in USDI to get short the dollar for long-term gains.
Here’s a pair I think will benefit tremendously in such a scenario: NZDUSD (the New Zealand dollar versus the dollar).
NZDUSD features an upside-down version of what we just saw in USDI, namely an inverted head and shoulders:
The breakout above this pattern’s neckline confirmed a reversal of the long-term bear trend in NZDUSD and should lead to significantly higher prices over time.
I would look at any kind of setback in NZDUSD to establish long positions. That includes a pullback all the way to the neckline of the inverted head and shoulders. That’s because markets often seek the level from which they broke out before continuing with the new trend.
If this happens in NZDUSD, I’ll be a buyer.
Another interesting pair that’s starting to reverse against the dollar is GBPUSD (the British pound versus the dollar):
GBPUSD has been in a long-term 10-year downtrend from over 2.00 to about 1.15 at the height of the pandemic.
But since that time, it’s been steadily climbing higher with important support patterns underlying the rise. Those include an Eve and Adam double bottom. This is a fairly unusual bottoming pattern where the Eve bottom consists of multiple pokes at one low and the Adam bottom is only a single attempt.
So there’s a double bottom here in GBPUSD, albeit one that looks a bit different from LYFT.
But it does demonstrate these price patterns and price actions occur repeatedly across different asset classes. And that's why I put so much emphasis on looking objectively at price patterns and price action.
We often don't know why or a market is turning when it does. That's only revealed much, much later.
But the market tends to be well ahead of events before they’re “known”.
And GBPUSD has indicated a turn for quite some time, especially since breaking above a major resistance level around 1.35. That level is now an area of consolidation.
In fact, there’s a coil forming right above that neckline right now. This represents a suppression of energy that should be unleashed in the direction indicated by the underlying pattern and trend – up.
Of course, there could be a slight pullback here as the dollar strengthens in the short term.
However, I would use that as an opportunity to establish long positions. If you’re not long already, also consider putting a buy stop above last week's inside bar in case that pullback doesn’t occur.
Once GBPUSD breaks above that level, the move could be explosive.
Now here’s USDJPY (the dollar versus the Japanese yen) which is a very curious chart:
As I've been warning for last several weeks, be careful if you’re looking to get short USDJPY because it looked like there was a trap a bit below the support level at 102 – 103.
That trap was somewhat sprung last week. USDJPY started to turn against its giant downtrend. That trend has been in force for the last several months.
Yet there was initially a bullish key reversal right at support, and then USDJPY surged last week.
However, I don’t feel this will lead to a major move higher. USDJPY may rise as high as the trendline of the descending triangle in which it’s been traveling, but 106 – 108 is likely to be the high point.
I'm certainly not going to use this movement to get long despite the obvious momentum. That’s because this is inherently a bearish chart and I expect prices to turn back in the direction of the long-term trend.
Now here’s EURJPY (the Euro versus the Japanese yen) at the monthly level:
I’m reviewing the monthly chart to give you a long-term view of where this pair might stop dead in its tracks and revert to the downside once again. After all, EURJPY has seen a surge from the lows around 112 to the current level of 127.
But like USDJPY, I believe EURJPY’s short-term rise won’t last. This pair could rise as high as 130 where it intersects the long-term downtrend line.
I did suggest members get long EURJPY several weeks ago around 126 and right now it's hovering a little over 127. There could be a few hundred pips to go before this short-term momentum gets exhausted.
However, the governing patterns (a head and shoulders and a double top) suggest EURJPY will inevitably feel the pull to the downside. Stay long for now but be prepared to exit if the momentum fails.
Now onto the precious metals …
Here’s XAGUSD (spot silver) which on the surface looks like a perfect setup for a trade that will go higher.
When I say “on the surface” it’s because there’s a host of bullish price patterns. Those patterns include an inverted head and shoulders which formed the basis of a breakout from silver’s seven year, long-term downtrend last July.
That reversal from the prevailing downtrend strongly suggests a new trend that will steadily rise over time.
To add to the bullishness, there’s also a double bottom as part of what looks like an inverted head and shoulders most recently.
However, what concerns me is the overall volatility that has taken place since the breakout – silver had an almost $3 range last week. Typically, you prefer to see a slow build for a sustainable long-term uptrend.
In contrast, extreme volatility makes it hard to assess good risk/reward situations.
If you're going to trade silver, the only way to do it is with very wide stops. Adopt a long-term view and ensure your stops are wide enough to handle large price swings.
Any new leg of a silver uptrend has to clear the $28 - $30 level to confirm the next phase.
A potentially safer way to play XAGUSD movements is to take a position in the iShares Silver ETF (symbol SLV). If you're looking to stick silver in your portfolio for the long haul, this may be a better way to play it without excessive worries over wild volatility.
Now here’s XAUUSD (spot gold) which contrasts with the strength we see in silver:
Gold has been descending with lower highs since the summer. This has traced out a bearish descending triangle.
In earlier times, gold was much stronger than silver but since summer 2021 those roles have reversed.
This is why you have to treat each trading instrument individually. You can't trade silver as if it's gold and you can't trade gold as if it's silver. You have to look at each one on its own merits.
Anyway, gold’s weakness has developed within the boundaries of what looks to be an ascending, broadening formation. I wouldn’t rule out another descent to the lower edge of this pattern.
This suggests gold could drop as low as $1,700 before resuming a new leg in its bull market.
If you believe that’s too pessimistic, gold has seen some bullish key reversals recently. The yellow metal could be finding support near current levels. If so, gold’s bottom may instead be at the $1,800 level and it will never go near the lower edge of that ascending broadening formation.
The important level to watch is last week’s lows. However, if gold takes out those prices, then it’s likely to retreat all the way back to $1,700.
So I'm going to be watching the price action around last week's inside bar and how it plays out.
And that’s it for this week!
Again, thanks for all the well wishes about my surgery and I hope I can recover ASAP.
To recap, I’m waiting for a safer risk/reward setup before considering shorting the NASDAQ. In the meantime I’m currently long shares in LYFT. I’m long-term bearish on the US dollar and therefore see any pullbacks in NZDUSD and GBPUSD as buying opportunities. I feel USDJPY are shorts, but not yet. I’m tentatively bullish on silver despite the extreme volatility and neutral to bearish on gold. That’s because there's still an overhang in gold but much less of a concern in silver.
I wish you a very healthy and prosperous trading week.
Mark "Game(Stop)ification" Shawzin