I never thought I’d see the day when Lam Research (NASDAQ:LRCX) stock would be four times hotter than Nvidia (NASDAQ:NVDA) and Advanced Micro Devices (NASDAQ:AMD) in a quarter. But Nvidia stock is up still up 150% year-to-date, so it’s still the overall king but it has lagged of late.
NVDA stock price has seen its range tighten to a point, so there is evidently a big move brewing soon. We don’t know the direction yet but spoiler alert: I think it will be up.
But first let’s revisit the fundamentals. Nvidia stock is the clear-cut chip champ this year. It has finally unseated AMD, which reigned for the past two years. Company outlook is beyond reproach ans all the experts agree on that point. Management has positioned the company to power the tech brains of the future.
My position on the chip competition is that tech demand is so great that all three companies will prosper. There is, in fact, room for AMD and Intel (NASDAQ:INTC) to have more business than they can handle. This year’s quarantines gave the concept a shot of adrenaline, starting a panicked rush into everything online. The digital revolution has kicked into hyper-drive.
Valuation matters, and it doesn’t tell a great story. But that’s okay: it doesn’t really matter at this point because Nvidia stock is delivering phenomenal growth. This has earned it a pass on Wall Street over profitability.
Investors should focus only on how successfully the company is growing its top line. They can insist on profits later when that stagnates, which looks to be years out. For now, management needs to spend a lot of money to grow, otherwise they fall behind. This is a concept that Amazon (NASDAQ:AMZN) perfected. The critics who shorted it for a decade based on bad margins lost a lot of money.
There is a bone to pick with NVDA price-to-sales, as that metric is almost double that of AMD. AMD has a higher P/E but its stock price is more realistic. Neither is completely bloated, but there’s more hot air in the NVDA stock price now. As long as markets in general are bullish, that won’t be an issue. But if we hit a snag, that potential froth will price out quickly.
The Short-Term Opportunity In Nvidia Stock
This leaves us the opportunity on the charts. When the price action in a successful stock tightens like this, I usually favor the upside breakout.
In this case, Nvidia stock has set higher-lows for the last six months, so the bulls are in complete control. For the past month they have struggled with taking out $550 per share and holding it. Now there will be a showdown between bulls and bears to decide who takes it for the next leg.
If the buyers can close above $551 per share, we’ll see a breakout that could set new all-time highs. This won’t be easy because the last three efforts around this level have failed. Those occurred in September, then a month later in October and most recently in early November.
Conversely, bears will have to exert a lot of effort to break through the support that lies below. There are a lot of buyers ready to catch the falling knife at several stages. The zone extends from $520 to 467 per share. That is a lot of work and it doesn’t seem like the bears have enough energy for it.
Therefore my guess is that the bulls will overwhelm them and the breakout will happen sooner rather than later. For that reason, investors should hold the stock for the next few weeks. If the markets hold up more generally, this breakout is happening.
If this is a trade not an investment, then it would be smart to set stop loss levels. Those vary from one investor to another based on risk appetites; there isn’t a one size fits all trading style.
For example, I favor selling puts to create income from potential rallies because I get paid to participate. The downside of that is that I settle for caps over profits. By selling a put, I can still win from a bullish trade even if the stock falls. For example I can sell the January $460 put and collect $5 for it. Whether the breakout happens or not, as long as Nvidia stock doesn’t fall more than 13%, I’ll be a winner.
This can be part of a pair trade. Investors can buy stock or call options to participate in the upside, and partially sell some puts to collect premium. The net effect is a smaller out-of-pocket expense and half the bet has a hedged.
Just Don’t Short it and Buy the Dip
The most important point of today is not to short Nvidia stock expecting a debacle. That’s not going to happen because the management team is too strong and the fundamentals are too solid. It would take a major disaster, either in the market indices or in the company’s success. Neither of those situations is imminent, so by default the upside is more likely to happen than not.
I don’t usually condone jumping the gun anticipating a breakout, but in this case I don’t mind it. If for whatever reason the bears prevail and there is a sell-off, I would still definitely buy the dip. The aggression with which I would do that depends on the depth of the correction. If Nvidia stock falls below $480 per share, it would make for an excellent long-term entry for all investors. The important part is neither to panic nor have too much hope.
On the date of publication, Nicolas Chahine did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Nicolas Chahine is the managing director of SellSpreads.com.
