While the broader large-cap and technology equity indices in an unabated fashion continue to push higher, underneath the surface there have been plenty of performers in recent months. One such name is Domino’s Pizza, Inc. (NYSE:DPZ), which as a result of its latest leg lower is now only higher by about 6% for the year after being up about 40% in June.
Since I last offered my bearish view on DPZ stock on Oct. 20 the path of least resistance has indeed resolved to the downside — about 10% thus far, and my first downside target has been reached. In many ways this trade represent one of the highest probability scenarios I have witnessed in my thus-far 20-year career as a trade and investor, and that is the phenomena of mean reversion.
You see, gravity in financial markets works much the same as it does in physics, which is to say that overextended assets (i.e. stocks) will ultimately mean-revert lower to find a better balance of supply and demand, or what we refer to as price discovery.
DPZ Stock Charts
Moving averages legend: red – 200 week, blue – 100 week, yellow – 50 week
Looking at the longer-term chart of DPZ stock, we see that in October of 2016, the stock began to pierce above its longer-term trends, which led to a classic overshooting move higher. While this move measured about 45%, you can see that it deflated much quicker than it took to build. Although stocks can remain in dramatic overbought or oversold states for much longer than most people have the patience for, ultimately a mean-reversion move stands a very high chance.
As a result of the mean-reversion period since June, the stock has now once again re-entered its longer-term uptrending channel. From where I sit, this now makes new short positions significantly less attractive than they were even just one month ago, but there could still be further downside.
Moving averages legend: red – 200 day, blue – 100 day, yellow – 50 day
On the daily chart, we see that the entire price action that took place above the up-trending channel this year also formed a bearish head and shoulders pattern as marked by the blue bubbles. The drop since the completion of the right shoulder so far has measured 20% and increasingly looks to be at least near-term oversold. Typically in these formations once the neckline (black horizontal) gets violated, then a counter-trend bounce occurs which then leads to a next leg lower again.
While this is not my base case, it is worth mentioning that should this head-and-shoulders pattern play out in a text book manner then the ultimate downside target for DPZ stock could be closer to the $1,130 mark.
For now, I am happy with the near-term short we put on in this stock and am taking profits. If and when an oversold bounce should occur in this stock, which is then followed by a bearish reversal it could set up for a next short-side trade again.
Check out Anthony Mirhaydari’s Daily Market Outlook for Nov. 9.
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