Thursday, December 29, 2016

ServiceNow Struggling to Break Out of Wave 4

ServiceNow (NYSE: NOW), yet another technology professional services and cloud provider, posted what appeared to be a beat on earnings and a beat on revenue for the eighth consecutive quarter.  The result, however, appears to be an exhaustion gap and an immediate decline into an Elliott Wave 4 correction.

NOW Daily Chart
 The reason for the near immediate selling may be found in this statement in the company's third quarter earnings press release:  "Our financial measures under GAAP include stock-based compensation expense, the amortization of debt discount and issuance costs related to the convertible senior notes, amortization of purchased intangibles, legal settlements, business combination and other related costs, and the related income tax effects of these adjustments. We believe the presentation of operating results that exclude these items provides useful supplemental information to investors and facilitates the analysis of our core operating results and comparison of operating results across reporting periods."

While the non-GAAP earnings posted a positive EPS of $0.24, beating estimates by $0.03, the GAAP earnings posted a negative EPS of $0.22.  In other words, when you consider their actual expenses using generally accepted accounting principles, they lost $36.3 million.  That would easily explain the exhaustion gap and the subsequent troubles the stock has endured since their 26 October announcement.

Looking a bit closer at the chart, we see that the current uptrend started on 8 February 2016, coming off the 52-week low.  The impulse included three complete Elliott waves, with Wave-1 and Wave-3 sub-dividing into five impulse waves, and Wave-2 sub-dividing into a three-wave a-b-c correction.  The uptrend produced a bullish channel, although the boundaries of that channel were violated in both directions on several occasions. 

The exhaustion gap that ended Wave 3 produced a double top with a retest of the high on 25 November.  That double top was confirmed in Wave 4 with a breach of the neckline on 1 December, and the price target was met on 2 December.  That move down was swift and decisive.  In fact, from 28 November to 2 December, the pattern displays a significant change of character, and signals a fundamental sentiment shift that we'd do well not to ignore.

The current phase certainly appears to be a complex correction in Wave 4.  Right now, the 200-day moving average is providing support and the 10-day moving average is providing resistance. With those two lines converging, something will have to give shortly.  Note, too, that the initial tend-line formed by the impulse channel was breached decisively on 1 December.  Since then, a new support trend-line appears to have formed connecting back to the Wave 2 lows.

The RSI(9) oscillator isn't offering much directional guidance at the moment.  Rather, it has simply confirmed each of the prior moves, but does not currently show any divergence in either direction.  I do show three trend-lines in the RSI since a breach of those lines may prove to be the directional signal we need.

With the complex correction either in flight or having just completed, we need to be mindful of the ensuring Wave-5 development.  Wave-4 has already retraced 61.8% of Wave-3, and in so doing it dropped below the top of Wave-1.  That's a violation of the Elliott Wave guidelines, and purists will discard the count because of it, however it's been my experience that it's a guideline that's broken frequently.  So I use that point more as a reference point for a potential reversal, but I don't stress over a breach of that line.

It's important to note that, in the current impulse, Wave-3 ended shorter than Wave-1.  That means that Wave-5 must be shorter than Wave-3.  (That rule is inviolate.  For a valid Elliott Wave count, the third wave cannot be the shortest of Waves 1, 3, and 5.)  I've marked the maximum height permitted for Wave-5 on the chart in a thick red line. 

Can we realistically expect to hit that target given the negative indicators we're seeing on the chart?  Not likely.  A truncated Wave-5 that hits the 61.8% extension is a more realistic target, and that's what we'll use in our reward to risk calculations.

Given the way the stock has behaved since 28 November, we will consider a close above the 10-day EMA as a valid buy signal. That's especially true if we can get some confirming volume, and with traders getting back to work on 3 January, that's a distinct possibility.  Our objective is to catch the Wave-5 ride, and that could be a nice 12-point swing from where we are now.  As a result, we're not going to be too aggressive with our protective stops, but will keep them below major support levels along the way.  For now, that means a stop below the channel support line.  We'll move it up as appropriate, again giving the stock room to breathe.  We expect Wave-5 to sub-divide into 5 impulse waves, as well.

NOW reports their 4Q earnings after the close on 25 January.  We expect Wave-5 to complete by then, or possibly as part of those earnings.  Either way, 25 January 2017 is our deadline to be out of this stock.  We won't hold it across that earnings announcement since we saw what a seemingly good report on 3Q did to it.  Now, holding this stock for up to three weeks is much longer than our typical holding period, however given the potential to ride that final push before a distribution phase makes it an attractive prospect.  Of course, you many also choose to play the stops tight and attempt to catch the three impulse sub-waves in Wave 5.  That's more a matter of style and your availability during the trading day, however.  Given that we expect it to be a short wave, I'm not convinced the slippage in this case is worth hopping in and out.  It's one of the rare cases where I'll try to catch the breakout of Wave 4 and ride the entire Wave 5. 

Happy Trading.

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