Shares of Microsoft (NASDAQ:MSFT) have rallied about 25% since last October. This, on top of an already steep rally. The company just released a strong earnings report and the stock is rallying even further.
From a technical perspective, the stock is in a parabolic rally. It’s likely very close to exhaustion buying that will stall the stock and/or lead to a mean-reversion lower for a trade.
As a student of market history, one of the most common phenomena in markets that I have come across is that of ‘mean-reversion,’ or the tendency for stocks to take a breather after a strong rally and vice versa on strong selling sprees. The trick, of course, is to get a feeling for when the parabolic move is close to being over.
Because gaining some context when analyzing a stock is of crucial importance, it is notable that the sharp rally in mega-cap stocks such as Microsoft stock since October 2019 were likely aided by the significant increase of the Federal Reserve’s balance sheet. That in turn led more investors to chase these stocks higher, for passive investors (i.e., with ETFs) to allocate more to these stocks, and trend-following algorithms to add further fuel to the fire.
This is not to take anything away from the great story and company that Microsoft is in my opinion, nor to belittle their latest earnings report from this week. My point here is purely around the slope of the chart, which at these vertical degrees is at high risk of a mean-reversion lower.
MSFT Stock Charts
On the multi-year weekly chart we see how steep the rally in MSFT stock has become in recent months. We can also see how from a momentum perspective as measured by the weekly MACD oscillator at the bottom of the chart, the stock is severely overbought.
On the daily chart, the stock continues to further remove itself on the upside from its medium-term moving averages (the yellow 50-day moving average).
Following the Jan. 29 earnings report, Microsoft stock in after hours trading rallied 4% – 5% to as high as $176.20, thus overshooting even its steepest of ascending channels.
Trading Microsoft Stock
Less risk averse traders and investors could look to take small short positions in Microsoft on this latest pop, i.e., the post-earnings rally on top of the already vertical chart from recent months’ rallies.
Options traders could look to sell far out of the money call spreads (credit spreads) or simply buy some protective or speculative puts. As a next downside target, once mean-reversion sets in, I see MSFT dropping toward the low $160s, which measured from the thus far overnight highs could be close to a 10% move.
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