This Stock Offers Good Reward-to-Risk

Shares of Domino’s Pizza, Inc. (NYSE:DPZ) last week fell about 14% on the back of the company’s latest earnings report on July 25. While the company’s financial report beat both analyst top- and bottom-line estimates some concern arose around international sales growth, sending the stock lower.

DPZ stock, however, remains a terrific trend following stock in my eyes and this latest sell-off all else being equal should provide opportunity for the bulls.

Trend following as a trading and investment strategy in my eye is one of the most sturdy and time-tested strategies, performing well in both bull and bear markets — provided one sticks to the strategy rules.

What are these rules you ask? Good trending stocks and other assets tend to trade in easily depicted and well-defined up or down trends.

Bullish trending stocks thus are best to be bought on retracements back to the lower end of their trading range and sold (at least in partial profit taking) at the upper end of the range.

DPZ Stock Charts

Moving averages legend: red – 200 week, blue – 100 week, yellow – 50 week

To explain this more visually, let’s look at the multiyear weekly chart of DPZ stock. Here we see that DPZ has been trending higher in a well-defined channel (purple-dotted parallels) for years, getting overbought at top of the channel and oversold at the lower end of the channel. Then in October of last year, the stock broke out above this channel and after some retesting of the upper end of the multiyear channel formed a new and more intermediate term steeper channel as marked by the black parallels.

While such “range extension” moves can and will happen from time to time, the longer-standing trend channels tend to be the ones that stocks mean-revert back to.

Note that this past May DPZ stock proceeded to rally eve more steeply and by so doing overshot its new and steeper up-trending channel. But by doing so the stock through the lens of trend following very simply got extended, which is to say that last week’s 14% drop in the stock was merely a mean-reversion move that was overdue.

As a result of last week’s selloff, DPZ stock has now arrived back at the lower end of its new channel (black parallels), which also just about coincides with the yellow 50-week simple moving average that has been holding as support for years.

Moving averages legend: red – 200 day, blue – 100 day, yellow – 50 day

On the daily chart this can be seen even better. Here I, used the red 200-day simple moving average, which roughly equates to the 50-week moving average. Note that it coincides with the lower end of the latest up-trending channel.

While a bullish reversal (strong buying day or failed intraday selloff) has yet to occur, for traders and trend followers alike this now provides a good reward to risk opportunity to buy the stock. If the stock turns back lower and closes below the 200 day and the trend line around the $180 mark on at least a daily closing basis, then the trade would simply stop out.

If the trend, however, continues, then a more intermediate-term upside target once again becomes the $210-$220 area.

In the event that DPZ does break and hold below the $180 area it could target the lower end of the multiyear channel from the above chart, i.e. in the $150-$160 zone.

— Serge Berger

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Source: Investor Place