Facebook Stock May Complete Head and Shoulders Top

Shares of Facebook, Inc. (FB) fell nearly 7% on Monday following disclosures of a privacy breach that affected an estimated 50 million users. The controversy raised calls for a Congressional investigation, while the United Kingdom may issue subpoenas to locally based Cambridge Analytica, the company cited for the incident. The news adds to growing concerns that the social media giant is doing a poor job of insulating its massive customer base from political manipulation.

Unfortunately for bulls, four-month price action is carving the right shoulder of a possible head and shoulders pattern that will issue major sell signals if the decline breaks neckline and moving average support, now located in the mid-$160s. In turn, that would favor continued downside into the $130s, shaking out a large supply of shareholders who haven't had to deal with a major decline since the summer of 2015, when the stock fell more than 25% in a month. (See also: Facebook Shares Fall After Data Leak Bombshell.)

Facebook Weekly Chart (2013 – 2018)

A vertical uptrend posted a series of new highs into February 2014 and eased into a logarithmic scale rising channel, indicating strong institutional buying interest. Channel support has roughly tracked the 50-week exponential moving average (EMA), with multiple pullbacks finding support at that level in the past four years. The last major test took place between November 2016 and January 2017, with the stock carving a flat base and taking off in the strongest rally impulse in four years.

The stock reached channel resistance in July 2017 and stalled out, failing multiple attempts to break out above $175. It finally accomplished that feat in November, but momentum buyers failed to appear, yielding mixed price action into this week's decline, which posted the highest volume since April 2016. Facebook shares are now trading just five points above the 50-week EMA, marking a line in the sand that bulls must hold to avoid much larger downside.

The weekly stochastics oscillator has carved an unusual pattern since January 2017, hitting the overbought level quickly and dropping into a shallow downturn that has not touched the oversold line in 14 months. The monthly indicator has issued clearer directional signals during this period, entering a sell cycle in December 2017 that predicts at least six to nine months of relative weakness.

(Learn more about relative strength indicators in Chapter 4 of the Technical Analysis course on the Investopedia Academy)

Facebook Daily Chart (2016 – 2018)

The uptrend that started in January 2017 has drawn the rough outline of an Elliott five-wave advance, climaxing with February 2018's failed breakout above $190. The decline into Feb. 9 ended at the 200-day EMA, marking the first trip into that long-term support level since the uptrend began. Monday's sell-off settled above the February low but right on top of the moving average.

Price action since October has carved a possible head and shoulders topping pattern that will complete the right shoulder with a decline into $165. The pattern's popularity with armchair technicians lowers the odds for a simple breakdown because it tends to attract weak-handed short sellers that predatory algorithms can easily squeeze into submission. As a result, a decline through the head and shoulders neckline may undergo several whipsaws before an orderly trend sets into motion.

On-balance volume (OBV) topped out in November and failed to break out with price in February. It has now dropped to a six-week low but remains high in the multi-year pattern, suggesting that it will take a major catalyst for shareholders give up long-term positions. Informed market players will be watching the lower red line, marking the mid-January low, with an indicator breakdown coinciding with a sell-off through $165. (For more, see: Why Facebook Shares Could Fall 20%.)

The Bottom Line

Facebook stock has been under distribution in the past four months, carving a possible head and shoulders topping pattern. A breakdown through neckline support in the mid-$160s could unnerve complacent shareholders, dropping the stock into a major downtrend. (For additional reading, check out: Facebook's Security Chief Plans to Resign: Reports.)

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

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