The battle against gravity came to a crashing end on Monday for Roblox (NYSE:RBLX). Shares of the red-hot videogame company tumbled 10.8%, with over 57 million shares changing hands. But the comeuppance is hardly surprising. After all, RBLX stock nearly doubled in a few weeks. You don’t get that type of upside volatility without some significant turbulence once all the demand finally dries up.
Source: Michael Vi / Shutterstock.com
As large as a double-digit percentage drop might seem, it’s actually both worse and better than you might think.
First, Roblox gapped up at the open to notch a new record before the selling began. From the day’s high, prices actually sold off 15%. That’s the “worst” part.
As for the “better,” well, despite such a dramatic downturn, prices have returned to where they were last Wednesday. It would need to fall another 20% before even reaching the 20-day moving average. If that doesn’t tell you just how hilariously overbought the stock was, then I don’t know what will.
The singular question that comes to mind when analyzing this pullback is, “do you think the dip gets bought?”
My answer is yes, and I’ll give you three reasons why: price, volume and earnings growth.
Why RBLX Stock Will Get Scooped Up
In technical analysis “kindergarten” they teach you that a trend in motion stays in motion. To keep it simple — Roblox is very much in an uptrend, so we should assume all retracements get scooped up before we fall far enough to reverse the trend.
But it goes beyond simply parroting the mantra of “buy the dip.” The momentum of the movement is important too. Prices didn’t just make a higher pivot high on the most recent advance. They did so with a massive expansion in momentum.
With that power level behind the trend, it’s even more compelling to bet the next drop is a buy.
Source: The thinkorswim® platform from TD Ameritrade
Next up is volume, or the level of participation during the recent surge. Fundamentally, there are two groups of participants: institutions and individuals. The former includes banks, hedge funds, pension funds, mutual funds and the like. They are the stewards of pooled capital and have deep pockets. Because of their size, they leave footprints when they move into and out of markets.
Buying and selling for them isn’t an event. It’s a process. As such, we say that they both accumulate and distribute shares.
High volume up days are known as accumulation days. They signal institutions entering the market and provide a bullish backdrop to price movement.
Participation exploded during the Nov. 9 earnings response, but it wasn’t a one-off. We’ve continued to see massive volume every day since. It has been a veritable stampede. I find it hard to see these newfound fans altogether abandoning RBLX stock during the next dip.
That means I bet we see a higher pivot low form above the previous one ($93).
While traders arguably got too far over their skis on this one, that doesn’t mean the launch happened completely on fluff. The earnings numbers did show underlying improvement for the business, and management painted a rosy picture for Q4.
Because Monday was the first day of the pullback, I both expect and hope for downside follow-through. Whether that means two or three red days or more remains to be seen. Regardless, I like selling bull put spreads once signs of buyers return. For a high probability of profit, I usually sell puts with a delta of less than 20, while getting at least a 10% return.
Here are the strikes that currently fit the bill. However, I would adjust to lower strikes if we see RBLX stock fall further.
The Trade: Sell the Dec $95/$90 bull put spread for 55 cents.
On the date of publication, Tyler Craig did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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