The Twitter Turn, Part 2

Summary

• After nearly hitting $50, Twitter drops 20%.
• As the RSI 'surged' to all-time highs, I shorted the stock.
• A deeper dive into stock cycles and sentiment.
• This idea was first discussed with members of my private investing community, Fusion Trading . To get an exclusive ‘first look’ at my best ideas, subscribe today >>

Trends often lead to excess moves. By utilizing simple price driven tools, sentiment analysis, and contrarian thinking, we can 'fade' or sell that excess to the public.

In "The Twitter Turn, Part 1", I wrote a bit about how speculative stocks top, how bases are formed, what to look for in a quality name, and the overall nature of the Twitter (TWTR) turnaround from $14 to the mid-$30s. The article was mostly related to describing the cycle of an equity, loosely shown here:

The long-term Twitter chart I highlighted at the time can be seen below. After declining for years, the stock built a multi-year base before breaking out. From here it made one more run to the upper $40s. This is a good example of a stock cycle, going from liquidation into accumulation, and then into a markup.

Today, I want to further the conversation of topping strategies during the 'distribution' phase. Below I will show how I used an RSI 'surge' to short twitter at $46 and $47 in June. I will also show how using a relatively simple option strategy, I was able to define my risk nicely.

Distribution Phase: Doji Tops

In "The Twitter Turn, Part 1", I highlighted 'doji' tops from a variety of speculative tops in names like Shake Shack (SHAK), GoPro (GPRO), Tesla (TSLA) and of course Twitter when it topped out post-IPO in 2014. These all turned into big turning points and large downside trades.

Whenever writing about candle formations, I always expect comments. Last article was no different. What was nice was seeing readers step in and correct those with less experience with price action.

Precisely. A "doji" is an 'indecision' candle. It suggests a market that is unclear about its next direction. When this happens after a major move (either direction), it warns a reversal is in play.

I've updated one of my examples from the previous article as this stock has collapsed even further since its "doji top". Let's look at what might be the most historic doji top ever, Helios and Matheson Analytics (OTC:HMNY).

Keep in mind, the doji formed after a near 6X move in the stock, meaning a strong trend was in place, a precondition for reversal. Furthermore, this was, and is, a very troubled stock. Since then, the price has outright collapsed.

Candlestick analysis can be used on any time frame and dojis obviously do not always create such sharp reversals. After calling for a melt up in 2017 when most were urging caution ("The Melt Up"), one of the biggest reasons I became so cautious this year is that in Q1, the S&P 500 printed a large doji.

How would you describe 2018 so far? Would the word indecision sum it up? Below I show the quarterly doji candle, coupled with the daily action since then.

You can see all the 'doji' top examples in "The Twitter Turn Part 1".

The RSI 'Surge'

An RSI 'surge' is another strategy I deploy when looking to fade an asset, particularly one I believe is heading into a distributive phase.

For those interested, more information on the RSI indicator and the math behind it can be found here: RSI Tutorial-Stockcharts.

Although often incorrectly used as an overbought/oversold indicator, the RSI I find is best utilized within a trend, as a confirmation/non-confirmation indicator.

The chart below shows the multi-decade gold price with the RSI above. What you can see is during uptrends, there are bull RSI ranges (40-90), and during downtrends, bear RSI ranges (20-70).

In my view, this is the cleanest way to apply an RSI, which is to simply to give an idea of what kind trend you are in (bull vs. bear), and where within that trend you are (upper, middle, lower range). This then opens the door to a 'surge' component, and alerting as to when it is time to exit.

RSI Surge

The diagram below draws this 'surge' concept out in more detail. Essentially, a normal running RSI trend turns to a surge. This is not to say all trends surge, but those that do offer unique opportunities.

Bitcoins RSI surges to 90+

In December of 2017, I wrote 'The Bitcoin Bonanza, Part 1'. In it, I said the following...

I followed up 10 days later on my Twitter feed with the chart and comments below. The RSI had reached 93+ (bottom panel) and jumped outside its trend, suggesting extreme action. This ultimately was the top.

Twitter RSI hits an all-time high

Twitter's RSI surge was no different than the Bitcoin move above. Although they are different assets, the human psychology behind trading them is the same.

The hopes of making money, getting rich, fear of being left out, and other forms of chasing behavior are not confined to cryptocurrencies. The bottom line is we can measure, identify, and then capitalize on panic buying behavior.

On June 12th, I put out the following trade alert focusing on out of the money bear call spreads as Twitter's RSI 'surged' to 87. This trade had 4 major components:

• RSI nearing all-time high, meaning price extended.
• Earnings gap from 2015 'leak', meaning an area of resistance.
• Proprietary buying 'panic' indicator fires, meaning capitulation type action.
• Choosing to trade a bear call spread instead of puts or shorting the common, higher probability selection.

Valuation at the time on an FCF yield basis had dropped to just under 2%. A fair place to see some price slowdown, and certainly a different valuation than when price was yielding near 6% on an FCF basis.

An additional sign of extreme bullish action was the convertible bond issuance on easy terms. One week prior, on June 6th, Twitter issued nearly $1B in convertibles, with a coupon of .25% and a conversion rate of 42.5% (strike of $57). This is about as easy as it gets from an issuer standpoint, and another sign everyone on the long side was in the pool so to speak.

But back to the Twitter short in terms of execution. 2 days later on June 14th, I saw my same proprietary panic buying signals fire off for the second time.

Therefore, I added to my bear call spread position. You can see the RSI also surged to 89, the highest in the entire history of the company, including the IPO rally.

July 18th

One month later, on July 18th, the RSI had finally come back down, while price had basically gone nowhere since my entry. For the astute, you will recognize by this point the trade worked and was one of the primary reasons I chose a bear call spread vs. puts or being short the common (betting the stock would simply stop going up vs. large scale reversal = higher probability).

I got the sideways action needed to close out, as most 'out of the money' calls sold had soured. But depending on time frames, there was still extrinsic value in the longer dated options.

An important point above is recognizing how powerful price was capped post the RSI 'surge' in June. The reason was simple, all the bulls were trapped after chasing the stock. Coupled with the earnings gap resistance, and the proprietary buying panic, I had a strong sense of a trend exhaustion.

There were numerous traders who then tried to trade this 'flag' a few weeks later to the upside afterwards as well, to no avail. They simply didn't recognize price was exhausted, and the move finished.

The final nail, however, would come on earnings last week. This decline was dramatic and swift and ended any notion of option value for even the longer dated calls.

Most of the OTM calls sold from the literally 2-day June RSI surge and buying panic were zeroed out. This is effectively how the masses are often fooled, and how stock is distributed on the public. It can be quick, aggressive, and deeply psychological.

Conclusion:

Equities cycle from periods of accumulation, to markup, to distribution, to markdowns and on again. The end of a trend and overall exhaustion set up good selling/buying opportunities as the risk of sideways to a reversal in prices far exceeds any additional move.

Although it's impossible to know how prices will play out, risk vs. reward often hits extremes when momentum peaks. By utilizing smart yet simple technical, behavioral, and fundamental techniques, we can better manage positions.

From the models above, many stock management strategies can be created, from outright shorting to neutral strategies (as shown) to even things like covered calls allowing one to profit while continuing to stay invested longer term.

Thanks for reading....

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

The Twitter bear call spreads have all been closed.