When a company delivers a positive earnings report and increases its outlook for the full year, it's usually a good bet that its stock will garner some buyers. But when a stock initially rallies on the news only to spend the rest of the day falling on heavy volume, we can surmise that something is not right.
That's exactly what happened to Darden Restaurants (NYSE: DRI) on Tuesday.
The restaurant operator announced better-than-expected earnings before the bell, increased its outlook and announced a new $500 million buyback plan.
The stock instantly jumped more than 4% from Monday's close. But it was all downhill from there. By Tuesday's close, shares had given up nearly all of those gains, closing up just 0.6%.
While the media will report it as a gain on positive earnings news, the charts say otherwise. Bad action on good news is bearish.
DRI, as well as a good deal of the restaurant sector, has been in a decline since the summertime. Darden peaked in June and fell through mid-July before settling into a sideways range. But within that range there were clues to suggest there was more pain ahead.
First, the range had a flat top and rising bottom, which created an ascending triangle pattern. Triangles can resolve in either direction, but the ascending variety tend to lean bullish. After all, the rising lower border suggests bulls getting active earlier on each swing within the pattern.
But the stochastics momentum indicator, shown at the bottom of the chart, told quite a different story. Steady lows but falling highs in the indicator suggested the stock spent more time actually falling than rising. And the indicator's opposition to the price pattern served as a warning for the breakdown that occurred last week.
The earnings action on the charts showed a failed attempt to move above the top of the pattern, followed by a strong move back down to the pattern's bottom. Typically, these breakout failures telegraph a move back down to support. And they rarely stop there, as support frequently cannot hold the bears in check.
In the case of Darden, the pre-market jump was halted at strong overhead resistance dating back several months, and the resultant failure left the stock below both its key 50-day and 200-day moving averages. It also confirmed the breakdown of a double-top pattern on weekly charts to add some big-picture weakness to the mix.
So, let's recap: With Darden, we have a stock with a breakout failure on strong earnings, long-term double-top confirmation and a weak sector. There isn't much more for the bears to ask for except perhaps downside follow-through after the earnings sell-off.
We can come up with a target by measuring the height of the triangle pattern at its widest part and projecting that down from last week's initial breakdown point. That leaves us with a first speed bump at roughly $57.65 and a more likely target at twice that distance at $53.70.
While some traders may wish to wait for a bearish follow-through to lower risk, they could end up sacrificing gains. But there is another way you can lower risk while acting immediately. It involves a "backdoor" method used by the smartest traders on Wall Street. If you'd like in on the secret, access this free presentation.
Recommended Trade Setup:
-- Sell DRI short at the market price
-- Set stop-loss at $65
-- Set initial price target at $53.70 for a potential 13% gain in eight weeks