After nearly 5 months the Facebook Stock Predictor has generated a Sell signal.

The Sell signal means that, based on historical trading patterns dating back to the stock’s IPO in May 2012, the algorithm has assessed a high probability of further declines from today’s levels.

This algorithm has had a high degree of accuracy to date so we have every reason to follow it, however in this current euphoric upward trend, it would be wise to use caution.

We have stated before that we do not like to short a stock outright, as this is one of the most inefficient ways of profiting from trading (just ask Carson Block). A number of fundamental, statistical, technical, and arbitrage factors would need to be in place to support an outright short sell for us to take the trade. Having said that, a re-examining of Facebook’s current bullish factors would be in order…

In “Leaping Onto A Fast Moving Train“, we wrote about the ‘perfect storm’ of upside factors for Facebook stock:

1. Facebook has captured the imaginations of a lot of investors, most who are anticipating Facebook to be larger than Google. Anecdotally speaking, we know many people including our own friends and family who just have to have a piece of this stock.

This is still true today. The sentiment on StockTwits is also 96% bullish, and 76% of NASDAQ community members are bulls, although some contrarians (like us) might view this as a bearish sign.

2. Facebook has a very short history of price discovery (it’s only been a year and a half since the IPO). The stock has successfully probed a bottom, but is still in search of a meaningful top.

This is still true today. A new all time high was reached only last week, but it has not yet had a significant push to challenge this level.

3. Many large institutions have accumulated the stock in anticipation of public demand (and perhaps counting on the average investor’s continued tendency to buy at market tops).

Not as true, so far: As of the 13f filing quarter ending June 30, this seemed to be the case, however as more institutions file for the quarter-end September 30, the number of new buyers is uninspiring – see our post ‘Facebook: who’s buying‘ for more detail. In addition to this, the daily trading volume is well below the average, possibly leaving the stock suspended in a state of zero-gravity that trades horizontally (neither up nor down). This state can lead to easy manipulation by large players, painting a series of false break outs leading up to Facebook’s earnings announcement on October 30.

4. As a result of #3, there have been very few significant pull-backs in the stock during this run. We saw an 8% pull back in the first 2 weeks of August, then a 7% pull back to start the week of September 15. In between, the stock rose 27 and 22% respectively, but the pullbacks and the legs up continue to be smaller in size…

Not true today: We have seen 2 significant pull backs in October. The first one was met with greater buying as price recovered and then some. The one this week has yet to retrace. The Stock Predictor seems to think the chances are not as good this time around, and we have no reason not to believe it.

Out of the 4 bullish factors outlined above, 2 of them have turned bearish. Thus it would seem that an outright short sell is not a ‘slam dunk’ (as Goldman would say). It would be prudent at this point to use the current signal as a ‘bias’ and wait for a meaningful down trend to develop and additional negative factors to develop before taking a short position. The more aggressive traders who use our signals and analysis in conjunction with their own due diligence, may wish to deploy an Options strategy to capitalize on any down-move while improving the risk to reward.

For us, we are setting a stop-loss for the algorithm’s Short position at a price that we will communicate to our email list members. If this level is triggered then the Stock Predictor algorithm will maintain a flat position until the next signal.

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