Chart Of The Day: Sell Citi On Earnings, But Buy On Technicals

Citigroup’s trading pattern broke out of its moderate rising channel, which suggests a steeper climb going forward. This may be preceded by a minor correction. That would jibe with fundamental analyst expectations of all-around disappointing earnings for banks.

The price of Citigroup has been trading within a mildly rising channel this year, in which it gained 16% in value from the February's $55.23 low to $64 in late June. After that, it broke out of the channel, crossing through the resistance of its top, now expected to turn to support, as it continues to climb more steeply. It climbed 7.5 percent in just four trading days, which included a 3.75 percent gap on June 29.

Fundamentally, the rising gap occurred on the bank’s overwhelmingly successful stress test which the Fed released on June 28. This was followed by Citigroup’s commitment to repurchase up to $15.6 billion of common stock over the next year and double its quarterly dividend to 32 cents per share, bringing total payouts to $18.9 billion. Technically, the gap followed a breakout of a bullish falling flag, a continuation pattern.

The flag’s upside breakout gap raises a red flag. After the gap, prices extended gains over the following 3 days, all of which were lost in the following 4 days. In fact, yesterday’s closing price of $66.82 is lower than the closing price on June 29 after the gap at $66.98.

While the decline in itself doesn’t negate the bullish implication of the channel breakout, the breakaway gap could turn out to be an exhaustion gap, a prelude to an Island Reversal, to be completed with a second, falling, gap. And what better catalyst for that than a disappointing earnings report? The price hovering right at the top of the gap suggests that investors are waiting for earnings, in order to figure out where to go from there.

First, the preceding trading doesn’t support the case of an exhaustion gap, which follows earlier gaps, when none occurred. It’s called an exhaustion gap because it’s the last gasp for demand which comes at the top of a frenzied buying spree.

That doesn’t seem to be the case here, as the gap actually followed the flag – a consolidation, by definition – as well as congested trading since April. We also know the fundamental reason for the gap and it's justified.

Second, even if it does turn out to be an exhaustion gap, after a falling gap would complete an island reversal, its downside implication is no more than the rising gap. That would put it right on top of the support of the channel top, from which it would be expected to resume its uptrend.

Conservative traders would probably wait on a long for a potential island reversal and a return to the support of the channel top, which would be around $65.

Moderate traders are likely to wait on a long for a potential dip toward the June 29 low of $66.26, before earnings.

Aggressive traders would go long now, in case of an earnings surprise, which would be a catalyst for a price jump, while placing a stop-loss as far below as possible toward the $65.36 bottom of the gap, a support, or even to the channel top, on $64.50, per the current angle. Traders: it’s bad enough to lose money when you’re wrong, but it’s horrible to lose money when you’re right. That’s what would happen if you don’t protect your trade with the appropriate stop-loss.

Very Aggressive traders would short the stock, on the impending fundamental disappointment compounded by the falling gap potential of an island reversal, before going long. Also, the RSI provided sell signals when it fell after reaching its most oversold read since the Trump election.

Written By: Investing.com