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Chart Advisor: About Face

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Thursday, February 25, 2021

1/ Did investors just flip to fear? 

2/ Travel industry trade looks flimsy 

3/ Is this market revisting the WSB/GME panic?

4/ The bottom line

1/ Did Investors Just Flip to Fear? 

Stocks fell hard leaving traditionally bearish patterns on most charts that looked bullish the day before. State Street’s S&P 500 ETF (SPY) has a big red candle after a mild gap down to start the session, but Invesco’s Nasdaq 100 ETF (QQQ) has created the foundation of a head-and-shoulders pattern. Individual chart patterns rarely have useful predictive value. However, an experienced Chartered Market Technician (CMT) will be quick to tell anyone who would listen, that when a preponderance of stocks begin to show similar patterns throughout the market, you’d better pay attention. It could be a harbinger of a major trend change in the not-too-distant future.  

Today’s price action captured in the chart below is rather instructive. Notice how the Cboe Volatility Index (VIX) spiked above 30 today, and closed at a level higher than its highest reading two days ago. The equivalent move for SPY would be for it to close noticeably below 380—lower than two days ago. But SPY didn’t close that low, meaning the reading on the VIX is forecasting more selling to come.  

Equally interesting is the shape of the price action on QQQ. Both price and volume patterns are following the classic buildup of the head-and-shoulders pattern. The next two features for it to be complete would include the establishment of a lower high swing in price over the next week or two, and then a close below the dotted line. This would imply that the price trend that had pushed prices higher since April 2020 was coming to an end and that investors could see a multi-week, or even multi-month, downward trend. At least that is the textbook definition of how that pattern manifests itself in hindsight. 

However, one small fact that is not widely known is that a failed head-and-shoulders pattern is one of the most reliably bullish signals known to technical analysts. Could this current selloff be setting up a great buying opportunity? There are reasons to believe such a thing could be true, but it is dangerous for ambitious traders to go all in on such a belief. Consider the following two stories to see how a chart watcher might be able to tread carefully and still be ready for unexpected opportunities. 

2/ Travel Industry Trade Looks Flimsy 

It is useful to review yesterday’s chart of ETF Managers’ Travel Tech ETF (AWAY) and three cruise line companies, Carnival Corp. (CCL), Royal Caribbean Group (RCL) and Norwegian Cruise Line Holdings (NCLH). Today’s trading action showed a stunning reversal playing out as a bearish engulfing candle pattern appeared on all four charts. This outcome is coincident with Bookings (BKNG) trading similarly lower even though the company made a stunning earnings beat. 

It is possible that market sentiment has turned bearish overnight and that the travel trade—a risky play nowadays by any definition—became a luxury investors felt they simply couldn’t afford. Analysts at Credit Suisse (CSopined that pensions funds doing monthly rebalancing might also be weighing on the markets today. If this were true, it could imply that the sentiment change was temporary and will right itself next week.  

If that were to play out, the chart below would be an easy place to see it. The first thing that would happen would be that prices in this chart would fail to close below their lowest point of today’s trading. The second thing to occur would be that these trades would begin to move higher on Monday. If both of those things were in place, it would constitute a failure of the bearish engulfing signal. These patterns have poor performance records anyway, even if they play out as forecast, according to technical trading author Tom Bulkowski

3/ Is This Market Revisiting the WSB/GME Panic? 

There is one possible explanation for today’s action worth exploring: a sentiment of uncertainty about the solvency of hedge funds. Strange but true, the GameStop (GME) trade driven by the WallStreetBets crowd on Reddit could, (gasp) be right!  

Here’s how the explanation goes: those who believe that there are many hedge funds still in naked short positions on GME expect that they will have to face margin calls by the end of this month. This theme has been written about on Reddit for several weeks, so people have been waiting for this opportunity. Hedge funds who have been caught in the trade may have been patiently waiting out the retail traders, expecting that they won’t be forced to close positions at a loss if they can just be patient. 

The first weakness to the ‘stay-short-and-don’t-cover’ strategy is that if exchanges exact a margin call for those holding the shorts, then they could be forced to sell at least some of their position, whether they want to or not. This would therefore result in the predicted short squeeze, and the mad rush to buy shares, that the Reddit readers have been hoping for.  

All of this talk would amount to so much hope and hype common to decades worth of message board chatter regarding an endless stream of tickers if it weren’t for one important coincidence. The notable selling across all indexes today might seem unrelated unless there are a significant number of firms who actually ARE caught in the trade. At that point, investing firms begin to look at one another in terms of counterparty risk—much as they did in late 2007. A crisis of confidence could begin to take hold.  

That means that if a true short squeeze occurs on GME, and the rest of the market is somehow connected to the effects of that squeeze, the results could have very negative impact for many investors. The greater likelihood is that this is the last gap for the GME crowd. However, nothing is certain in the markets. 

4/ The Bottom Line 

Stock prices abruptly changed their behavior from yesterday to today, implying new worries. Evidence for this is strong in the travel sector and it may be related to the GameStop trade.        

Originally Published on February 25, 2021

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