Momentum investors have abandoned common sense and gone mad over a new announcement in the world of video games.
Alphabet’s Google GOOG, +2.10% GOOGL, +1.99% has announced a cloud-based gaming service called Stadia. Stadia is meant to be the Netflix NFLX, +4.58% of gaming. Gamers will be able to stream complex games to their screens without needing consoles or high-powered graphic chips in their computers.
Let’s explore how the momentum crowd is viewing Advanced Micro Devices AMD, -1.15% incorrectly.
Read: Google and Nvidia display competing views of the future of streaming videogames
Chart
Please click here for an annotated chart of AMD. Please note the following:
• The chart shows there is a strong move in AMD’s stock on the announcement that Stadia will use a custom AMD chip.
• The announcement should not have been a surprise to anyone who carefully studies the gaming space. AMD chips have been used in consoles from Microsoft MSFT, -0.11% and Sony SNE, -4.94%
• The chart shows that AMD’s stock broke out.
• Algorithms at The Arora Report show that a big part of the rise has been due to a short squeeze. In a short squeeze, short sellers panic and buy to cover their positions. This creates artificial demand for the stock.
• There are not many things that I know with certainty about the markets. You may be familiar with Arora’s Second Law of Investing: No one knows with certainty what is going to happen next. However, I do know with certainty that all short squeezes ultimately end. When a short squeeze ends, the stock falls. The process always creates a lot of bag holders in the momentum crowd.
• The chart shows the resistance zone. This means that the stock can go up a lot from here.
• The chart also shows two support zones.
• The chart shows that RSI (relative strength index) is overbought but the stock has room to run.
• The chart shows that the breakout has occurred on high volume. This is a big positive.
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Technical analysis conclusion
Based on the foregoing, from traditional technical analysis, the conclusion is that this is a picture-perfect setup to back up the truck and buy AMD’s stock. Such a view may be reinforced by the following two factors:
• The short squeeze has barely started and can go on for a while.
• This market is controlled by the momentum crowd. The “momo” crowd can run up a stock much higher than can be justified based on fundamentals.
To some degree, what happens next will depend on the trajectory of the Dow Jones Industrial Average DJIA, -0.55% S&P 500 ETF SPY, -0.30% and Nasdaq 100 ETF QQQ, +0.40% Please see “With stocks at an inflection point, it’s time to look at the world like a technical analyst.”
Keep in mind that the traditional technical analysis no longer works as well as it used to; please click here to see the reasons.
Abandoning common sense
Ask yourself the following questions and you will readily see that the momo crowd has gone mad.
• AMD chips are widely used in gaming consoles. When gaming consoles go away, how much business will AMD lose?
• AMD and Nvidia NVDA, -0.75% chips are widely used in gaming computers. When the need for gaming computers goes away, how much business will AMD lose?
• AMD is gaining some business from Alphabet. But this business will pale in comparison to the business that AMD will lose because of the above two factors. Why is AMD’s stock being bought so aggressively on the news that, ultimately, AMD will lose revenue?
• Google is not alone. Ultimately expect Microsoft, Amazon AMZN, +2.01% Apple AAPL, +0.87% Facebook FB, +2.40% Sony, Verizon VZ, +0.30% and AT&T T, -0.55% to jump into the business of game streaming. Will AMD face competition?
• Is anybody still holding GameStop GME, -4.20% ?
• Buy AMD on this news if you think there is a bright future for GameStop. GameStop is a brick-and-mortar retailer of video games and consoles. Does anyone remember Blockbuster, the one-time darling of the momo crowd?
What to do now
Here is a case where common sense flies in the face of picture-perfect technical analysis.
What to do now depends on if you are a nimble day trader or an investor.
If you are a nimble day trader, by all means dance while the music is playing — buy AMD. As a note of caution, use very tight stops and other risk-control measures.
If you are an investor not holding AMD stock, consider staying away from it at this time. There will be better opportunities in the future to buy it. At The Arora Report, we have had a large number of profitable trades on AMD.
If you are an investor holding AMD stock, slowly scale out into the strength.
If you are an aggressive, experienced investor, consider scaling in a short position on a further short squeeze but with appropriate risk controls.
Use this chart as your guide.
Before you write me ...
Before you write me about gaming vendors such as Electronic Arts EA, -0.49% Activision ATVI, -0.56% and Take-Two Interactive TTWO, +0.28% these will be the subject of a future post.
Also understand that Intel INTC, -0.65% is not on par for graphics needed for serious gaming. Also, the AMD announcement will have no material impact on Micron Technology MU, -0.59%
Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.