Online shopping has reduced the once chunky margins of large, out-of-town superstores, and a race to the bottom has ensued, with efficient discounting machines such as Aldi and Lidl hacking away at the fat of the Big Four grocers.
And yet Ocado sits at just under a £10bn market cap. Much expectation has clearly been built into the share price here, and indeed losses are forecast to come down in the next consecutive years from 2020. But everybody knows (or is it just my opinion?) that broker forecasts are not worth the paper they’re printed on. It’s impossible to predict what will happen in the next six months – never mind three years. The damage Covid-19 has done is unquantifiable and dropping money into the market on a fundamental basis requires a healthy dose of both braveryand luck. The beauty of charting is that it focuses on what matters: the money-weighted sum of the entire market’s expectations.
Those who were expecting the stock to do badly in 2018 got a nasty shock on 17 May, when the company announced a statement regarding a new international partnership. This was with Kroger (US:KR) – a US company that was “one of the world’s biggest grocery retailers”, with sales of $122bn. The objective of the agreement was to allow Kroger exclusively to use Ocado’s Smart Platform technology in order to enhance the grocery customer’s experience.
There were no numbers in terms of contract detail, although Kroger subscribed for5 per cent of Ocado stock at a value of £183m. This was also surprise news, and so the stock gapped up at the market open. Those who recall my ‘Mind the Gap’ article (IC, 14 February 2020) know that trading gaps can be a profitable strategy – unexpected news results in a gap, which often sees a follow-through in buy-side volume where we can ride the coattails. This scalp trade is exactly what happened on Ocado.
Next, we saw a period of low volatility where neither the bulls nor the bears had the advantage in early morning trading. However, once the stock had blasted through the intraday high, those with short positions began to feel the squeeze. The price racked up gains from around 840p to 1,000p in the space of an hour, pushing the stock not far off a 100 per cent gain since the previous day’s close.
While I am an active and comfortable shorter of stocks, I take no sympathy in those who are squeezed. Anyone who is shorting a stock should already know that their risk is hypothetically unlimited, as there is no limit on how high a stock can go – unlike going long where 0p is the lowest possible price. For retail traders, shorters cannot lose more than what is in their account. Anyone who opens a spread bet account is automatically classed as retail, and one should think carefully before signing up to become a professional trader and giving away negative equity protection.
But where there is pain, there is gain. Profiting from the misfortunes of others is part of what trading is about, as others’ pain can distort the efficient pricing on stocks. So although I missed the fun of the short squeeze, I decided that 1,000p would be a nice entry point into shorting the stock myself. Everyone loves BRNs (Big Round Numbers), and the stock was sufficiently liquid enough that I could get in and out with no liquidity issues and close quickly should the squeeze continue. I closed my position too early here, as I covered my short at the 200 moving average. My goal is to pick a target, and if the target is hit, I close the position and move on. Never get attached to any single move if it wasn’t in your plan – bank and run.
I now see a potential long trade in Ocado, as the price has held up well in these market conditions, and any sign of strength in a bad market is a sign of potential outperformance. Granted, the virus has been great for driving customers to its website. But from my own experience, Ocado’s service is superior to its rivals and I don’t think it’s unfair to assume many new customers will remain customers, meaning the lifetime value of newly acquired customers could be high. People tend not to switch supermarkets unless they become seriously dissatisfied or they move house and somewhere is closer – the same might prove true online.
However, none of these assumptions matter for our trade. Let’s focus on the price action in Chart 2.
We can see a descending flag in action, with Ocado stock testing this twice in March only to close back above the bottom red line marking the flag. The stock then rallied to a new all-time high, but was sold into the next day (an exhaustion gap). The price is not far from its previous all-time high, which I believe may provide resistance. If the stock breaks through this, then a test of the new all-time high at 1,550p is on the cards and I see a long trade from a breakout of this point.
Regarding risk, I think it’s prudent not to stick around too long. The support level for the trade would be the previous all-time high, and if we want to place our stop below this level then we’d need to adjust our position size for this risk. Ocado’s shares are highly liquid, and while we can take a sizeable position, managing our risk first is always priority. If we get there, I’ll be taking the long trade at 1,550p.
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