Tesla (TSLA) stock is rebounding today after a weekend Tweet from CEO Elon Musk cast doubt on shares’ valuation and sent them down more than 2% on Monday.
Musk later backpedaled from his comment that the share price was "higher than we have the right to deserve," but his original observation is refreshing since most CEOs wouldn’t be so candid. Still, the stock is in danger of forming a head and shoulders topping formation pattern, which usually precedes a move lower.
In this pattern, a breakdown below the neckline is necessary for the bearish signal to be triggered, as can be seen in the chart below. While it is not perfectly symmetrical, there is a left shoulder that formed at the $320 level in May, a head that formed at $380 in June, and then a right shoulder that is forming at around $320 to $325 here in July. A move above $325 and a retest of $340 would negate this pattern.
The measured move of this pattern would land at around $80 from the neckline, which sits at $305. A measured move is calculated by taking the distance from the head to the neckline and then taking this distance and adding it to the neckline. For this example, if the neckline is at $305 and you have a measured move of $80 (and being that this is a bearish pattern with a downside target), you would take $305 and subtract $80 to get a $225 target. A close below this level would bring about a target of $240, which is where the stock found support in early March.
With earnings coming up in a few weeks, this is an important pattern to keep an eye on, making a stock drop more likely if quarterly results disappoint. For now, shares have shown resilience in the $305 area, and this pattern would only come into play should there be a breakdown below $305, which would represent a break of the neckline and support.
Until Tesla reports earnings, its stock should be influenced by how other big cap technology companies such as Amazon (AMZN), Alphabet (GOOGL) and Facebook (FB) perform, as they set the tone for the overall market and also give us insight as to how much volatility to expect this earnings season.
The Bottom Line
Tesla shares are at risk of a major breakdown should the stock fail to hold the key $305 level that it bounced off early last week. While it is more than reasonable for shares to correct, given their massive run so far this year, many market watchers are getting nervous over the company’s valuation, especially when Elon Musk echoes their concerns.