User review and local search website Yelp (YELP) — a stock that active investors and traders often keep on the radar — is in the news again.
But not in a good way.
Whenever I hear of lawsuits and/or accounting irregularities as it relates to a stock that I follow closely, I perk up. Often times such situations aren’t resolved within a week, but can drag on. And besides negative financial implications, they also can hurt a company’s image for an extended period of time. As such, the long side of the stocks involved are then mostly to be avoided until the dust settles.
On the other hand, active investors might find opportunities trying to short the stock, if good risk/reward parameters can be mapped out.
In the case of Yelp, the Federal Trade Commission said that it has received more than 2,000 complaints about the company in the last five years. Yelp, whose revenue model for the most part is based on advertising sales, allows its users to leave reviews on local restaurants, events and a host of other things.
The issue that seems to be biting back is around negative reviews left by users, which at the margin can hurt a local business more than a good review can help. All of this has accumulated to send Yelp to the Supreme Court of Virginia over a local business that was hurt by a negative review. This naturally raises questions about parts of Yelp’s business model, which on Thursday was directly reflected via a 6.6% haircut to YELP stock.
Yelp Stock Charts
From a technical perspective, the drop in Yelp stock off its early-March highs can so far be labeled as a mean-reversion move. However, the roughly 30% haircut in the stock isn’t just an idiosyncratic phenomenon, but rather also something that came in tandem with the selloff in the broader social media industry. Facebook (FB), for example, is also off roughly 18% in the same time period.
Those who were long YELP stock had plenty of time to get out. The first real warning sign came when Yelp slipped below its multimonth uptrend almost two weeks ago. Over the last week or so, YELP stock began to consolidate at its 100-day moving average (blue line), which took the shape of a classic bear flag pattern. This pattern was finally resolved to the downside yesterday as the stock was taken to the woodshed.
Given the situation around YELP stock that I have laid out from both the news and technical perspectives, investors and traders should avoid the long side of the stock for now.
Quicker traders could consider shorting the stock as it may gravitate toward its rising 200-day MA (red line) in the near future. Position size, however, should be fitted accordingly (i.e., smaller than usual).
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Download Serge’s trading plan in the Essence of Swing Trading e-book here. As of this writing, he did not hold a position in any of the aforementioned securities.