Both rallies came on company-specific news; NFLX signed an agreement with The Walt Disney (NYSE:DIS) regarding content, and BIG reported better-than-expected fiscal third-quarter losses and announced its chief executive officer was leaving the company.
Tuesday’s 10.50% rally in Big Lots and 14.00% rally in Netflix also changed the charts for the near-term and sets both of them up for a so-called “gap-trade.” Gaps are empty spaces on charts that exist when price from one bar to the next jumps (either up or down). Allow me to go through both charts and setups, one by one.
Netflix is synonymous with volatility and headlines. The stock has endured massive ups and downs in 2012, similar in pattern but nothing compared in magnitude to 2011. On April 24, the stock gapped down 14% on the day, after which the stock continued to fall, but what was also the beginning of a longer rounded-bottom building process that is continuing to this day. As the second part of the bottom building process the stock started to act jumpy in October and has since rallied hard, right back to where the stock opened for trading (bottom of the gap) on April 24.
Tuesday’s big rally in the stock left a huge outside day behind on the daily charts whereby the candle fully engulfed the previous 19 trading sessions – a very significant statement! Immediate-term, the stock is somewhat overbought. However, what I am waiting for is follow-through buying and thus an eventual push beyond Tuesday’s highs and into the gap zone (blue box on the chart below). At that point the ultimate target for the trade is the top of the gap near $102, although a move into half-way of the gap bear $95 is a solid target for now.
Big Lots for its part has less of a textbook bottom in place than Netflix and overall a somewhat inferior setup, but it too reached the bottom of a large gap on the back of Tuesday’s rally. A push and daily close above Tuesday’s high at $32.13 would trigger this trade with the ultimate gap-fill target near $38.70 and the more conservative mid-way target into the gap being closer to $35.30.
Immediate-term, this stock is also somewhat overbought and thus a little backing and filling would be healthy, should it decide to eventually move higher and into the gap zone.
Gap trades are what I classify as high probability setups where the probability of a profitable trade is clearly in the trader’s favor and the main risk lies with lack of discipline on the trade execution side.