THIS Is Why a Sell-Off Is Brewing in Facebook Stock

FB StockFB Stock: Dire Consequences

Facebook Inc (NASDAQ:FB) reported earnings after the close on February 1, 2017. At first glance, all seemed to be peachy, as it beat on both the top and bottom lines.

Investors applauded the earnings release and sent FB stock higher by three percent, to a new-all time high of $137.25 in after-hours trading.

The following day, the initial bullish reactions to earnings quickly faded, and Facebook stock stalled, closing lower for the day. This price action didn’t completely catch me off guard because, in my earlier publication, “Facebook Stock Chart Suggests Caution Is Warranted,” I outlined that such a scenario could potentially play out.

This lackluster reaction to earnings and the bearish price action that followed both support the notion that my initial bearish view on Facebook was warranted. If this is indeed the case, then a sell-off in FB stock is set to ensue.

The following Facebook stock chart illustrates the pattern that originally initiated my bearish view.

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Chart courtesy of StockCharts.com

The bearish rising wedge, illustrated above, has been the focus of my last few publications on Facebook stock, and it has also been the cause of much grief.

A bearish rising wedge is a technical chart pattern that can be used to decipher the next direction in the price. This pattern contains two converging upward-sloping trend lines. One trend line represents a level of resistance, and the other trend line represents a level of support. These two trend lines contain the price as the pattern plays out. The pattern is resolved when the price exits the pattern in either an upward or downward direction.

Rising wedges are bearish patterns because, on average, the resolution to this pattern is to the downside. There is logic behind this view: the shape of the pattern requires a constant amount of buying pressure in order to contain the price within it. Any lack of buying pressure, and the price exits the pattern to the downside.

Facebook stock exited the the rising wedge pattern in a downward direction following a disappointing earnings announcement in November 2016, initiating my previous bearish view. This bearish view has been held with much angst as the price began to quickly move against it.

The following stock chart illustrates the price action that followed the completion of the bearish rising wedge.

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Chart courtesy of StockCharts.com

When the stock exited the rising wedge to the downside, it implied that the path of least resistance was lower, and that the price was expected to retreat to the lowest point from which the pattern began. This implies that Facebook stock was eventually going to test the August 2015 lows at $72.00.

That idea quickly started to crumble when the consolidation pattern highlighted in purple broke to the upside and suggested that FB stock was due to trend higher. It was the resolution of this pattern that left me with little choice but to retract my bearish view on Facebook stock and assume a neutral stance.

I didn’t assume a bullish stance because there were still bearish ramifications from the rising wedge. There was the possibility that the price was attempting to backtest the pattern from underneath. A backtest would serve to confirm the bearish outlook suggested by the pattern, and a sell-off would likely ensue after it was successfully completed.

When earnings were released after the close on February 1, 2017, Facebook stock surged higher, and it seemed as though the bearish ramifications suggested by the pattern were false, because the stock was trading at a new all-time high in after-hours trading.

The following day, to my surprise, FB stock failed to maintain those gains. There was a valiant effort to break through the bottom of the rising wedge, but selling pressure overwhelmed all the enthusiastic buyers. This price action was simply atrocious, and it supports the notion that the bearish view suggested by the rising wedge is once again warranted.

As a result of this price action, I am reinstating my bearish view on Facebook stock. Guarding against being wrong is not a very difficult task because, if the stock regains its footing and starts creating new highs, it would suggest that my renewed bearish view in FB stock is not warranted.

Bottom Line on Facebook Stock

A bearish price pattern on the FB stock chart was initiated in November 2016, and backtested in February 2017. Combine this pattern with the ramifications from the bearish price action that followed earnings, and it justifies reinstating my bearish view on Facebook stock.