Netflix Sell-Off Could Signal Deep Correction

Shares of Netflix, Inc. (NFLX) posted the biggest one-day percentage decline since July 2016 in Tuesday's session, caught in a tech plunge that could presage much lower prices following months of historic gains. The streaming entertainment giant had been the strongest of the FANG membership in 2018, gaining more than 70% in less than three months, but could now relinquish a good chunk of that upside.

The financial media is blaming trade fears and the Facebook, Inc. (FB) debacle for tech's malaise, but simpler forces may be at work. The leadership sector has been bought too aggressively in recent months, with the retail crowd jumping on expensive shares without regard to profit or revenue outlooks. The tide is now turning, with mean reversion seeking out support levels while shaking out weak hands, following the long-held observation that the bigger the move, the broader the base. (See also: Netflix Stock May Have Sprinted Ahead of Fundamentals: Stifel.)

NFLX Long-Term Chart (2004 – 2018)

A 16-month uptrend topped out at $5.68 in January 2004, just two weeks before the company issued its first stock split. It built a small top at that level and broke down, posting a 2005 low at $1.27 and turning higher once again. The rally stalled below the prior high in 2006, marking resistance that denied further upside until a 2009 breakout, two years after the company introduced its enormously popular streaming service.

The uptrend posted dramatic gains into the second half of 2011, reaching the low $40s ahead of a steep decline that hit the single digits in 2012. It bottomed out near $7.50 in the second half of the year and mounted the prior high in September 2013, ahead of a breakout that eased quickly into a trading range between the low $40s and upper $60s. A buying surge in the second half of 2015 cleared the barrier but stalled quickly as well, carving a higher range that generated sleepless nights for shareholders.

An October 2016 breakaway gap marked the end of the stair-step price action, generating a healthy trend advance that eased into a 2017 rising channel. It broke out above channel resistance in January 2018, gaining more than 100 points into mid-March's all-time high at $333.98, and has been pulling back since that time in sympathy with other FANG members. The monthly stochastics oscillator remains glued to the overbought level despite the downturn, but the weekly indicator has dropped into its first sell cycle since December 2017.

[Learn more about determining whether a stock is technically overbought or oversold in Chapter 4 of the Technical Analysis course on the Investopedia Academy]

NFLX Short-Term Chart (2016 – 2018)

Fibonacci grids stretched across the December 2017 through March 2018 and February through March rally waves organize vertical price action, highlighted by the unfilled Jan. 23 gap between $228 and $248. The stock penetrated the gap by 12 points during the February decline, leaving an eight-point hole that could attract magnetic bids. That sell-off reversed at the .618 retracement level of the broad uptrend, indicating that the $235 to $250 price zone marks a key battleground for bulls and bears.

On-balance volume (OBV) topped out in June 2015 when the stock was trading more than 200 points lower and entered a distribution wave that ended in February 2016. Buying power has failed to match price power since that time, with the indicator just reaching the prior high (blue line) in January 2018. Ominously, a breakout above that level has failed, telling us that this bearish volume divergence may now be exerting its considerable power. (For more, see: Amazon, Netflix Selling at 'Crazy' Prices Poised for Big Sell-Off.)

The Bottom Line

Netflix is trading below the 20-day simple moving average for the first time since December 2017 and could test the 50-day exponential moving average at $284 before attracting dip buyers. A break at that support level could set off longer-term sell signals, opening the door to a steep decline that could drop the tech giant into the $220s. (For additional reading, check out: Netflix Banned From Cannes Film Festival.)

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

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