The impact of the most recent outbreak of the coronavirus has had a violent impact on Chinese stocks. There is a sense of panic among the experts regarding the virus and this concern has spread onto Wall Street. The speed of infection outside of China is a factor, and what we still know little about its nuances. While experts are working hard on it, they have no known cure for it yet. And it probably won’t be available for a long time.
Today we try to answer if the dip in Chinese stocks like Baidu (NASDAQ:BIDU), Alibaba (NYSE:BABA) and Iqiyi (NASDAQ:IQ) is an opportunity to buy, or a bull trap.
All three stocks started the year with a tremendous rally. They had great momentum from November, but the the virus headlines squashed it. Chinese stocks were already lagging the U.S. markets because even after a big rally, only BABA kept pace with the S&P 500. Once the U.S. and China signed the first phase of the agreement Wall Street started playing catch-up with Chinese stocks, which fueled the rally.
The impact of the virus headlines caused a 13% selloff in the iShares Trust – iShares China Large-Cap ETF (NYSEARCA:FXI) and Alibaba. From recent highs to lows Baidu and Iqiyi dropped almost 20%. From a Wall Street perspective they all have had an official correction. So maybe buying the dip makes sense, but not all in at once. Investors hate uncertainty and until the authorities eliminate the unknowns about this strain of the virus, these stocks will be vulnerable for more downside.
Most headlines cause confusion but in reality very few affect the outcome of a stock forever. So the question now is to decide if enough of the virus’ impact is priced in. Since they don’t ring bells when that happens, it is important to study the charts for clues. Usually stocks have to consolidate after rallies to solidify levels as footing for more upside. It’s normal for a rally to fade or stall like this before it resumes higher.
Breakout patterns usually have three parts. The first is the rally, then comes the stall, which is unfolding now. Finally, the bulls try to breach the top of the rally again. If they succeed, they overshoot higher with another extension of the original push.
Each of the three Chinese stocks mentioned above are now the second phase of the breakout pattern. So the question now is if they hold this consolidation zone and use it as a base for higher highs.
Chinese Stocks to Trade Now: Alibaba (BABA)
In the middle of January, I cautioned about blindly chasing these stocks higher. It wasn’t an invitation to short but a statement that it was not an obvious entry point.
That proved correct.
Alibaba stock has about the same fundamental metrics as Facebook (NASDAQ:FB) or Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL). So it has similar prospects long term. It’s a successful business so if the stock markets are higher in the future, then so is BABA stock. On the week of Jan. 13, it set an all-time record for itself. This dip here merely brings it closer to the neckline from which the rally started. All this is part of normal price action.
Last October, the bulls breakout from $184 per share to launch a 26% rally. I consider this dip mere consolidation to digest the profits. On abrasive headlines, weak hands sell the stock. What’s left is a better base of investors that can take it to the next level higher. But for BABA stock, they first they would need to breach $231 per share. There are also resistance zones at $210, $215 and $220 per share, so it won’t be easy. Especially if the virus headlines don’t abate.
Conversely, if BABA stock falls below $200 per share, it could trigger another $15 leg lower. While this is not a forecast, it’s a possible scenario given the jittery air among investors. So taking a full position to catch this falling knife leaves no room to add on the extra dip if and when it comes.
Baidu (BIDU)
Baidu stock also lost footing after a great rally, but unlike BABA stock, it was far from its highs. In fact Baidu peaked in May of 2018. Even at the January highs, it was still almost 50% below its best. So immediately, this raises concerns over other issues that it may have had before this outbreak. Nevertheless, the concept of a bounce still exists.
Another differentiating factor is that BIDU failed going into a resistance zone near $155 per share that dates back to 2011. Those are usually difficult to overcome, so virus headline or not, this fade would have happened anyway. The headline merely triggered it. On a lower time frame, BIDU stock has resistance at $129 per share, so it will likely struggle there before it clears it to attack the next pivot at $148 per share. So it’s clear that the bulls have a lot of hard work to do. Unless the goal is to day trade, it’s best to be patient, even at the expense of missing out on a few upside ticks.
Here too there still is big downside risk. If Baidu falls below $120 per share, it could lose another $12 from there and maybe even fill the gap at $104 per share. If that happens, it should have some support at pivots near $113 per share. The recent chart pattern is an extreme wedge of lower highs knocking on the floorboard. If the floor holds, then the breach of the descending trend line would bring bulls relief. Otherwise, the pain will continue, so it’s best to avoid taking full positions to catch this correction.
Iqyi (IQ)
Iqiyi’s daily chart looks identical to that of BIDU. So the comments above also apply here, but at different dollar levels. I remember days when IQ stock was magically soaring and then crashing very hard. So the investors there might still have the inclination to over do it on trends in either direction. This makes IQ a potential wild card and somewhat of a lotto-like trade.
Like Baidu, IQ’s recent rally failed when it was still about 50% below its highs of 2018. It also failed at a natural spot that was a major ledge from April of 2019. So virus or not, IQ stock also was going to face the resistance anyway. It failed at exactly $25 per share and this makes for a great potential long entry if it’s taken out. There is resistance at $23 and stronger at $24, so patience is essential. I’d rather miss those $2 of upside potential to buy the breakout above $25 per share. When that happens, IQ could target $33 per share.
It is important to note the massive failure it had just under $30 off its February of 2019 earnings. This should serve as a reminder that this would be a speculative trade, one that should have entry and exit targets. Otherwise, we risk turning a trade into an investment and that’s not ideal for a momentum stock like this. The good thing about these stocks today is that they are online companies. So in theory their profit and loss statements should almost be immune to the virus effects on their sales. In fact it could provide a boost because if people are staying home, they are likely more active online.
Earlier here we described the third phase of the rally. It is important to note that if the last leg fails near the top again, then it risks developing a double-top. If the bulls fail to set a higher high, then the priority becomes to exit the longs before setting lower lows. Because, just like breaching the high would bring a second extension of the rally, losing the base would do the same in the opposite direction
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. Join his live chat room for free here.
