Tesla, Inc TSLA was trading slightly lower on Wednesday after a big bearish day on Tuesday caused the stock to close down 3.5% off the open.
The sharp decline was in reaction to a bearish head-and-shoulder pattern on the daily chart, which Benzinga pointed out following the stock’s 3-1 split on Aug. 25.
A head-and-shoulder pattern can be either a powerful reversal indicator when found at the top of an uptrend or a continuation pattern found in an downtrend.
The pattern is formed when a security forms a rounded or V-shaped arc and then declines (right shoulder) followed by a second steeper arc and accompanying downturn (head) and then by a third arc and decline that is shallower than the second (left shoulder).
The head-and-shoulder pattern has a neckline that is drawn using a straight ascending, descending or horizontal trendline across the peaks in the pattern.
When the security breaks down through the neckline on higher-than-average volume, it indicates the pattern was recognized and a sharp decline may follow.
Aggressive bearish traders may choose to enter a security in a head-and-shoulders pattern on the rise following the third arc, with a stop above the highest price in the arc. More conservative traders may wait to enter a position on a break down from the neckline.
- Bullish traders may wait to enter into a position if the security climbs above the highest price within the second arc, which negates the bearish head-and-shoulders pattern and indicates an accelerated move to the upside may follow.
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The Tesla Chart: The measured move of Tesla’s head-and-shoulder pattern is 10%, which suggests the stock could drop toward $255, which indicates that Tesla hascompleted about 3% of the measured move. If Tesla completes the entire move, it will likely occur over a longer period of time as the stock continues lower in its downtrend.
- The break down from the neckline of the head-and-shoulder pattern confirmed Tesla is trading in a downtrend. The most recent lower high within the trend was printed on Aug. 24 at $303.65 and the most recent lower low was formed at the $286.30 on Aug. 22.
- Traders can watch for Tesla to print a reversal candlestick, such as a doji or hammer candlestick, over the next few days to suggest the next lower low is in and a bounce to the upside could be in the cards.
- On Wednesday, Tesla was printing an inside bar pattern on the daily chart, with all of Wednesday’s price action taking place within Tuesday’s trading range.
- The pattern leans bearish because Tesla was trading lower before forming the inside bar, but traders can watch for a break up or down from the mother bar on higher-than-average volume to indicate the pattern was recognized.
- If Tesla breaks bearishly from the inside bar pattern, the 50-day simple moving average is trending slightly below the stock and may act as temporary support. Tesla’s eight-day exponential moving average (EMA) crossed below the 21-day EMA, which is bearish, and the two EMAs may continue to guide the stock lower.
- Tesla has resistance above at $285.83 and $300.90 and support below at $271.71 and $254.98.
Photo courtesy of Tesla.