The Week Ahead in Stocks – Aug 06

The price action in FAANG stocks over earnings season has been unusual in many respects. Facebook’s earnings drop produced the largest one-day decline in market cap ever. Netflix gapped 14% lower and rallied 12% in the same session. But away from the scale of the moves and the some of the unique catalysts, there was something very familiar in many of the falls. FAANG stocks, and momentum stocks in general, tend to correct with very sharp—almost trend-like—spikes lower which follow a set pattern. These spikes often constitute the entire correction, so when they complete, the trend resumes and targets new highs.

Identifying and understanding this pattern helps our trading in many respects. Firstly, our timing for both shorts and longs is improved. Secondly, we know not to expect a second decline in the classic “ABC” correctional pattern.

The first decline – wave “A” – is all we usually get.

Let’s look closer at the structure of some declines in Amazon (AMZN) on a 15m chart.

The same pattern can be seen in Google and Netflix.

And because markets are fractal, the same pattern can be seen in all time-frames. For example, the Netflix earnings crash on a 4hr chart looks almost identical.

One of the keys to understanding and trading this pattern is to be familiar with the different stages. The first decline is often hard to identify and can look like bullish consolidation. It is only when we see the gap lower or acceleration through the range lows that the rest of the pattern gets much easier to navigate. Any sharp recoveries after this stage will not fill the gap and are high probability shorts until new lows are made. Only at new lows can longs be considered.

We can condense all the above charts, and dozens, if not hundreds of historical examples in every time-frame, into one template—the FAANG flush fractal.

This is a pattern you will likely see time and time again. The issue is now that the much larger time-frames have, or are in the process of, completing this fractal, will it recover to new highs as it usually does. This is something we will be addressing over on Matrix in the coming weeks as earnings season draws to a close.

Good luck and good trading.

Andrew McElroy
Chief Stocks Analyst

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