A couple of weeks ago we discussed an inverse head and shoulders formation on Autohome (ATHM) and what that formation indicated for the future of its stock price.16980768497_c26b03d7ea_b

Today we’ll look at a head and shoulders formation on another stock, and then look further back in this stock’s chart to see if it gives us any clues that confirm our thesis on the head and shoulders formation.

The company we’re looking at today is Advanced Micro Devices (AMD).

AMD is a semiconductor company based in Sunnyvale, California. Their primary products include microprocessors, motherboard chipsets, and graphics processors for servers and personal computers.

The company’s most significant rivals are Intel and Nvidia, and the company stands to gain marketshare from both this year.

The debut of their Ryzen chips are expected to result in meaningful gains from Intel in desktop computers, and at half the price of Intel’s competing Core i7, AMD could disrupt the PC market considerably. And AMD’s new Vega graphics card, which will be announced later this year, will compete with Nvidia’s most powerful card to date, the GTX 1080 Ti.

Relative to these two peers, AMD is overvalued. The company isn’t profitable, its price to book is 31, and its price to cash flow is just above 127. Comparatively, Intel’s price to book is 2.5 and its price to cash flow is 8, while Nvidia’s price to book is 11 and price to cash flow is 41.7.

While from a fundamentals perspective, AMD isn’t a screaming bargain, I do think revenue and earnings growth will come from the new products described above, and the valuation will eventually catch up.

Despite the overvaluation, AMD has delivered outsized returns in the last 12 months, and is up about 435% from its 52-week low. From a technical standpoint, I believe there’s still more upside, and AMD’s chart is telling me that there’s potential for a good entry point in the near-term coming from a correction.

Let’s take a look.

AMD - H&S

Source: TradingView.

In the chart above, I’ve marked the head and shoulders formation on AMD’s daily chart.

A head and shoulders formation is the opposite of what we talked about with the inverse head and shoulders on ATHM discussed two weeks ago. To identify a head and shoulders formation, look for the price to rise to a trough (shoulder) and then fall, then rising above the first trough to form the head before falling again, and then the price rising again to form the second shoulder.

Once the second shoulder forms, the neckline can be drawn connecting the two lows between the head and the shoulders as shown above. In AMD’s case, the neckline points to the $12.50 level.

To get the price target for the correction, measure the distance between the top of the head and the neckline and then add that number to the price below the neckline. In this case, the downside target is roughly $10.

After the price hits the $12.50 and $10 levels, I expect that it will begin a new uptrend, and this head and shoulders pattern then represents a potential opportunity to jump in on AMD.

But how can we get more confirmation on all of this? Taking a look at the long term chart gives us some clues.

AMD Long

Source: TradingView.

The chart above is a monthly view of AMD. What we can see here is that the $15 level (marked by the blue line) is a significant resistance line for AMD’s price. $15 is also the price at the head of the head and shoulders formation that we’ve seen on AMD’s daily chart.

What’s also interesting is that if we look at the 38.2% and 30% Fibonacci retracements of the last high between 2006 and 2007, we can see that the $15 mark sits right between the two.

These historical indicators tell me that the head and shoulders formation that we’re seeing on the daily chart is significant, and reinforces that we’ll likely see the price drop to around $12.50 or $10 before beginning a new uptrend.

So what can you do with all of this?

If you’re already long AMD, set a trailing stop for $12.50 and then re-buy at $10. If you don’t already own AMD, watch for the price to fall to these levels and then take a position to catch the new uptrend. If you’re a more aggressive trader, you could also short AMD and then buy at $10.

AMD teaches us a great lesson here. If you spot a compelling pattern on a daily chart, looking back over the long-term can provide additional reinforcements.

As always, do your due diligence before taking a position. And for AMD, be aware that if there is a broader market correction, the stock is likely to be more at risk of a sell-off as it’s a small cap, overvalued, tech, and momentum stock, putting it in categories that investors would likely trim in a correction if or when there is one.

In AMD’s case, if this were to occur, the chart would look quite ugly before things get better, though a market correction would present great buying opportunities for AMD and other growth stocks.

Trade Smart,

Kristina Keene