Caution: Don’t Chase This Stock

Shares of Netflix, Inc. (NASDAQ:NFLX) rallied strongly following the company’s latest earnings report after the close of trading Monday.

While I remain a bull on NFLX stock through the intermediate- to longer-term lens, chasing it higher on the back of the latest post-earnings rally is a low probability trade from where I sit.

It never fails to amaze me how many traders, both retail and on the professional circuit, attempt to “profit” from an earnings report by positioning themselves ahead of the report.

By my empirical analysis and experience, the probability of making money by holding trading positions through an earnings report are 50/50 at the very best and more likely closer to 40% or worse.

Sure, some traders may have bought NFLX stock last week and are now getting rewarded by a strong up-gap and rally.

However, over time this is a low probability trade as the near-term direction of a stock following the earnings report can be up, down or sideways regardless of how good or bad a company’s earnings or outlook may be.

NFLX Stock Charts

Looking at the multiyear chart of NFLX stock, we see that one can draw a simple channel with the two black parallels. Each time the stock reached or marginally breached the upper end of this channel, it ultimately settled into a mean-reversion move lower through a multi-week/month lens.

In after-hours trading on Monday, NFLX stock rallied close to the $180 mark, which I highlighted on the charts with the blue arrow. In other words, barring any sudden reversal of fortune for the stock, it looks to be trading at or marginally above the very upper end said trading channel when trading opens today.

Is it possible the stock continues to rally for another few days and move toward the $200 mark in the near term? Certainly, anything is possible when momentum chasers get after a stock like this. However, as history shows on the above chart, odds are not in favor of buying at the upper end of ranges like this.

On the daily chart, we can draw another and more intermediate-term channel, the upper end of which also looks to be tested or marginally overshot when trading opens today following Monday’s earnings report. In addition to the upper end of range, NFLX stock near $180 or a little higher will also become very overbought from a momentum perspective and stretched above just about any near-to-intermediate-term moving average.

Lastly, traders have to ask themselves of they think real money investors will likely buy more NFLX stock upon a post-earnings ramp like this or if they are more likely to take some profits, or at least just wait for the stock to consolidate lower somewhat before buying more.

In my eye and in experience the latter is much more likely behavior for deep pocket investors.

As such, following the earnings rally active investors are best to stay away from chasing the stock higher and aggressive traders could even look to short the stock or sell out of the money call spreads should NFLX stock show a reversal of fortune, i.e. a bearish reversal following the initial up-gap after earnings. If and when a bearish reversal takes hold, then a downside target in the mid-to-high $160s becomes the next target.

— Serge Berger

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Source: Investor Place