Netflix Earnings Could Trap Overeager Bulls

Netflix, Inc. (NFLX) stock has made a rapid recovery off 11-month lows in the past three weeks, lifting to a three-month high above $350. The uptick of 120-plus points sets the stage for Thursday's eagerly awaited fourth quarter earnings release, when the entertainment giant is expected to report profits of 24 cents per share on $4.2 billion in revenues. The company beat top- and bottom-line expectations in October's confessional, triggering a 32-point rally, followed by a deep slide that trapped overeager buyers.

Straight-up price action since Dec. 26 has set off short-term overbought signals, raising the odds that a bullish report will trigger a two-sided reaction similar to October's pop and drop. Market players sitting on their hands could profit in that scenario, picking up shares much closer to $300 than $350. Conversely, an earnings shortfall or weak subscriber growth could trigger a nasty sell gap, trapping newly minted shareholders in a decline that fills the Jan. 4 gap between $274 and $278.

NFLX Long-Term Chart (2002 – 2019)

The company came public at a split-adjusted $1.16 in May 2002, when slow internet speeds limited business operations to mail-order DVD rentals. It sold off into the fourth quarter, posting an all-time low at 45 cents at the same time the internet bubble bear market was coming to an end. Buyers then took control, lifting price back to the IPO opening print in March 2003, ahead of a breakout that exhibited healthy buying interest.

The uptrend topped out at $5.68 in 2004, marking a high that wasn't breached until a 2009 breakout. That buying impulse attracted a strong momentum bid at the start of the new decade, lifting into the lower $40s in 2011. A steep correction reached the single digits in the third quarter of 2012, while a bounce hit new highs just one year later. Buying pressure then fizzled out once again, yielding sideways action that persisted into a 2015 breakout.

The monthly stochastics oscillator has carved three major sell cycles since 2016, with the last bearish impulse starting in September 2017. The second cycle into 2016 ended just above the first cycle low, while the latest incarnation crossed to the bull side at the same level as 2014. This synchronicity predicts that the correction has come to an end, with good odds that the stock will trade at new highs some time in 2019.

NFLX Short-Term Chart (2016 – 2019)

The uptrend leg that started in 2016 stair-stepped higher into June 2018's all-time high at $423.21, giving way to a steady decline that broke no major technical levels, except for a few sessions. This resilience is now coming into play, with the January 2019 uptick reaching within 65 points of the 2018 high. The vertical impulse into 2019 has now lifted above a trendline of lower highs going back to June as well as the .618 Fibonacci sell-off retracement level.

However, this positioning looks more like a trap than a breakout because the uptick has left behind four unfilled gaps. Two or three of these big holes are likely to get filled before price action successfully challenges the unfilled July sell-off gap between $385 and $391. In turn, this conflict indicates a potentially dangerous post-earnings reaction because an up gap into the low $380s could trigger a major reversal, ahead of a steep pullback that tests 50- and 200-day exponential moving average (EMA) support between $296 and $306.

Even so, the longer-term technical outlook remains highly bullish. The on-balance volume (OBV) accumulation-distribution indicator confirms loyal sponsorship, hitting an all-time high with price in 2018. The fourth quarter descent hit an 11-month low, well above levels that would signal shareholder disillusionment and fear. The indicator is also close enough to last year's high that limited buying power is needed for the stock to hit new highs without technical divergences.

The Bottom Line

Netflix heads into fourth quarter earnings after lifting more than 120 points in a short-term rally. It is now short-term overbought and in need of a pullback, raising the odds for a bull trap in reaction to positive metrics.

Disclosure: The author held no positions in the aforementioned securities at the time of publication.