Sunday Edition: Why Now Is The Wrong Time To Get In On This Chinese Growth Story

June 4, 2017

Sunday Edition: Why Now Is The Wrong Time To Get In On This Chinese Growth Story

Over the last few weeks we’ve discussed several technical patterns that can tell you when a stock may be beginning a new uptrend, so today I wanted to talk about a pattern that can help you spot the beginning of a new downtrend.

The stock we’re looking at today is Momo, Inc. (NYSE: MOMO).

Momo is a Chinese social networking app that made a name for itself through its large user base and its location-based online data, and has recently entered into the live video streaming market which has the potential to turn the company into a true powerhouse.

China is unique in that its government controls what citizens can access on the internet which has made it difficult, if not impossible, for foreign internet giants to gain marketshare in the country. Facebook, for example, has been banned in the country since 2009 and despite Mark Zuckerberg meeting with President Xi Jinping, that ban doesn’t look likely to be lifted any time soon.

But such an environment is also what gave rise to local internet giants Baidu, Alibaba, and YY, all of which trade on U.S. exchanges.

I’ve been looking at Momo in particular for a while now, and it’s not hard to understand why. The company is growing like crazy. Revenue grew by 421% last quarter. The number of active monthly users grew 18% year-over-year to 85 million. Even those who are paying to use the service have grown to 4.1 million.

These incredible growth numbers have seen Momo’s bottom line soar 633%, and there’s still room for growth with management guidance for top-line growth at 186% next quarter.

And with all this growth, Momo’s stock price has surged just over 100% since the beginning of the year. But I wouldn’t go buying just yet, and here’s why.

Source: TradingView.

What I’ve called out in Momo’s chart in the image above is a bearish engulfing pattern.

The bearish engulfing pattern is a candle pattern that establishes the end of an uptrend and is one of the most clear cut reversal signals.

You can identify the pattern by just two candles, and here’s how.

The first candle in the pattern can vary in size and isn’t pertinent to the pattern itself. The second candle, however, is as it is the reversal signal. This second candle is a long candle that fully engulfs the size of the first candle—thus the “engulfing pattern” name—and creates downward price momentum.

Ideally, the height of this second candle should extend above the high of the first candle and establish a new low. This downward movement reflects selling overtaking buying strength—selling pressure that is confirmed by looking at the volume levels along the bottom of the chart above—and usually comes just before a continued fall in price.

In the case of Momo, our second candle both extends above the high of our first candle, and  extends below it. Not only that, but the price has continued to decline since, giving further confirmation of the trend reversal.

Given this pattern, now might be a good time to take some profit in Momo if you’re already invested. But there may also an opportunity to make some money if you’re an aggressive trader and this new downtrend continues even further. If you are, you could short Momo. You could also buy put options with the expectation that the price will continue to fall.

Now, despite this downtrend, I’m still keeping my eye on Momo and will watch for any technical clues of a reversal to the upside in the future. When that reversal occurs, I’ll be sure to revisit the Momo growth story in another Sunday Edition. Stay tuned.