Roku, Inc. (ROKU) lifted to an all-time high last week after Needham analyst Laura Martin proposed a pairs trade in which investors buy Roku stock while selling an equal amount of Netflix, Inc. (NFLX). She reasoned that 2021 will “unmask fundamental weakness in NFLX’s growth story and also unmask ROKU’s powerful growth engine on its larger installed base.” Martin also believes that Dow component The Walt Disney Company (DIS) will take “industry leadership” away from Netflix in the next 18 to 24 months.
The stock has been an absolute monster this year, posting a phenomenal 240% year-to-date return. Under normal circumstances, the uptrend would be ripe for an intermediate correction that relinquishes at least 150 points, but that doesn’t seem to be in the cards because, as it stands right now, price action continues to fire on all cylinders, even though the majority of former momentum favorites have rolled over or are just treading water into year end.
Even so, we’re headed into January, when investors often sell the biggest winners of the prior year for tax purposes. It’s typical for the strongest stocks to struggle during this month, or even carve long-term topping patterns. Wall Street consensus seems to recognize this bearish seasonal phenomenon, dropping to a “Moderate Buy” rating on Roku shares based upon 12 “Buy,” 6 “Hold,” and 1 “Sell” recommendation. More importantly, price targets currently range from a low of $150 to a Street-high $375, while the stock is trading more than $60 above the median $260 target.
A pairs trade is a trading strategy that involves matching a long position with a short position in two stocks with a high correlation. It was first introduced in the mid-1980s by a group of technical analyst researchers that were employed by Morgan Stanley. The pairs trade strategy uses statistical and technical analysis to seek out potential market-neutral profits.
Roku Daily Chart (2018 – 2020)
The stock broke out in September at the same time the summer rally was coming to an end and has already exceeded common upside targets at the 1.618 and 2.000 Fibonacci extension levels. However, the uptrend has carved a number of small trading ranges, with each cluster now offering a trading floor during pullbacks. The overall pattern greatly relieves long-term overbought technical readings, favoring small downturns rather than a large-scale intermediate correction. As a result, Roku stock could find its way to $500 in coming months.
The 50-day EMA could also offer low-risk entry if the stock rolls over and sells off at the start of January. It remounted that intermediate barrier after the first quarter swoon, while four support tests into November found committed buyers. It has now been almost seven weeks since the last pullback, so the stock could be ripe for another downturn. The moving average is currently located in the $250s, or about 75 points below the current price.
Small signs of technical deterioration may foretell the next reversal. The stock has traded in a narrow channel for nearly one month, so a channel breakdown on the 60-minute chart could be actionable. Also watch the on-balance volume (OBV) accumulation-distribution indicator because it has been nearly pristine, hitting new highs and showing no signs of distribution. Better yet, daily volume bars could post the earliest warning because there hasn’t been a higher-than-average selloff day since Nov. 9.
Distribution stock refers to a large block of a security that is carefully sold into the market gradually in smaller blocks so as to inundate the market with sell orders for the security, driving down its price. Traders also refer to the dynamic of securities being sold this way as simply “distribution.”
The Bottom Line
Roku may pull back in January, but the stock has the potential to post extraordinary 2021 returns.
Disclosure: The author held no positions in the aforementioned securities at the time of publication.