Brick-and-mortar retailer GameStop Corp. (GME) reports third quarter earnings after Tuesday's closing bell as the short selling crowd gathers around, hoping to pounce on another shortfall. The company has fallen on hard times in recent years, losing hardware sales to internet juggernauts including Amazon.com, Inc. (AMZN) and software sales to direct downloads, online portals and cloud-based gaming.

However, the deep slide since late October has set off extremely oversold technical readings, while the broad retail sector has turned sharply higher, underpinned by a pre-holiday optimism wave. While it is unlikely that the worst has passed for GameStop, sector components may have arrived at deeply discounted levels that will encourage bottom fishing and short covering in the next three to six months.

GameStop's decline has also reached deep support at the 2012 low in the mid-teens, possibly offering a platform for a multi-week short squeeze following the news. However, traders should not stick around too long if the stock adds points at a rapid pace, because resistance above $21 may start the bearish cycle all over again, with a slow bleed that eventually yields bankruptcy or a discounted takeover by a more liquid rival. (See also: Game Over for GameStop Bulls.)

GME Long-Term Chart (2002 – 2017)

 

The company came public at a split-adjusted $9.63 in February 2002 and sold off to $3.75 one year later, marking the lowest low in the past 14 years. The subsequent uptrend gathered strength through the mid-decade bull market, reaching an all-time high at $63.77 in the first quarter of 2008. It plunged during the economic collapse, finding support at a three-year low in the mid-teens, ahead of a weak bounce that stalled in the lower $30s in the second quarter of 2009.

The stock spent the next three years testing support and grinding out a base with resistance in the upper $20s. It finally broke out in March 2013, entering a strong but short-lived uptrend that posted a lower high at $57.74 in November, marking the highest high in the past four years. The subsequent decline paused on top of the prior basing pattern and held that level into a 2015 breakdown, followed by a declining wedge that has now been in place for the past 22 months.

The downtrend has reached support at the lows posted between 2008 and 2012, while the monthly stochastics oscillator crossed into the oversold level in August 2017. It has been hovering at that extreme reading for the past three months, waiting for a bullish catalyst that could attract substantial buying momentum. A relatively upbeat third quarter earnings report may be all that is needed to set that oversold rally into motion. (For more, see: Best Buy, GameStop Expect Apple-Related Traffic.)

GME Short-Term Chart (2015 – 2017)

 

The stock is now sitting on declining wedge support near $15.50, while pattern resistance at $21 will be tough to break without intense buying power. This price structure opens the door to a five- or six-point short squeeze or recovery wave that could offer high-percentage profits to aggressively managed long positions. Even so, it makes sense to wait for the market's reaction to the quarterly report before taking exposure because a wedge breakdown could generate a selling spiral into the single digits.

On-balance volume (OBV) topped out in the fourth quarter of 2013 and entered an aggressive distribution wave that ended in late 2014. It has oscillated between range-bound highs and lows since that time, signaling periodic bottom fishing that has resulted in equally periodic capitulation. The indicator has now reached range support for the fifth time, predicting the start of a healthy buying cycle in line with extremely oversold technical readings. (To learn more, see: Uncover Market Sentiment With On-Balance Volume.)

The Bottom Line

GameStop shares have dropped nearly 35% so far in 2017, with long-suffering shareholders abandoning ship due to the paradigm shift out of brick-and-mortar sales, but the stock is now deeply oversold, raising the odds for a post-news short squeeze that gathers momentum through the holiday season. (For additional reading, check out: Can a Used-Game Rental Program Help GameStop?)

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

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