Block Ready For Reversal After Crashing 82% (Technical Analysis) (NYSE:SQ)

Investment thesis

Block, Inc. (NYSE:SQ) has lost 82% since the beginning of its decline, erasing almost all gains recorded since its pandemic low, and causing significant losses to long-term investors who bought the stock during its massive uptrend. While I rarely consider a stock in this stage, SQ attracted my attention as the stock is in front of breaking out from its most important resistance levels and despite the downside risk is still considerably high, the likelihood of a breakout is this time much more favorable when compared to past attempts. By respecting the discussed strict contingency plan and limiting the downside risk, investors could profit from a likely very positive outcome, leading me to rank Block as a buy position.

A quick look at the big picture

Companies in the information technology services industry have been modestly recovering in the past month, while other industries such as companies in the semiconductors industry, or software application providers have been leading the positive momentum in the US technology sector, after being severely sold off during the past year.

The Vanguard Information Technology ETF (VGT) bottomed on October 13, 2022, while only briefly breaking under its long-term moving average on its weekly chart, which the industry reference has been testing three times since the beginning of its sell-off. VGT is now testing its most important resistance, represented by its EMA55 on its weekly chart, and the EMA200 on its daily chart, a situation that could be observed for the fourth time during the downtrend, while each time the breakout has been rejected, leading VGT to test its support at the EMA200. More recently the industry reference seems to lose some relative strength when compared to the broader technology market, the Nasdaq Composite (IXIC), or more narrowly the Nasdaq-100 tracked by the Invesco QQQ ETF (QQQ), which could lead to assuming that the breakout could fail again, while it’s important to note that VGT is building increasingly positive momentum, confirmed by the rising MACD, a sign that the industry may instead continue in its favorable development in the coming months and the breakout could this time be confirmed.

Where are we now?

Block has been massively sold off since its All-Time-High [ATH] on August 5, 2021, crashing by over 82% and retracing almost all gains achieved since the pandemic low. The stock completed its downward Elliott impulse sequence, bottomed on October 14, 2022, and has since built some positive momentum by breaking out from its EMA21, which has been a strong trailing resistance on its weekly chart during the stock’s downtrend.

Having overcome its EMA21 on its weekly chart is the first step for SQ to break out from its long-term downtrend. The stock is now facing its EMA55 on increasing buy-side volume and sustained resilience in the past few weeks, but is still showing significant relative weakness when compared to the Nasdaq Composite (IXIC). More important than its past performance and the actual situation, are the hypotheses of the stock’s most likely future developments which I discuss in the coming section.

What is coming next?

Looking at the daily chart, SQ has successfully climbed over its EMA55 and even over its EMA144, two major resistances the stock didn’t manage to consistently overcome since the beginning of its decline, forming what I likely see as part of the C wave of its Elliott corrective sequence. The stock has lately shown to be able to build significant relative strength and has even closed the past week over its EMA200, a strong positive sign, which should now be confirmed during the coming week, in order to allow the stock to keep rising in its positive momentum.

If the stock is following the corrective wave hypothesis, wave C could extend most likely until $91.63, $105.83, or $114.61. This scenario would see the stock gaining strength while approaching Block’s expected Q4 and fiscal year report on February 23, which could deliver some catalyst and a clearer view of where the stock may be heading.

Despite the most recent encouraging developments, from a short-term perspective, I would be careful while considering investing in Block. Although on its daily chart, the stock looks increasingly positive, the weekly chart is still very gloomy and investors have to consider that SQ is still in stage four, a situation that is usually not advisable to be invested in, with rare exceptions in terms of early-stage contrarian strategies with a high-risk tolerance.

I want to see my scenarios forming or, otherwise, wait on the sidelines, and I, therefore, set my stop-loss tight under the EMA144 and later under the EMA55, or even track the price-action while setting a trailing stop within the EMA21. Dropping under these levels would expose investors to the risk of seeing the stock testing its bottom, which I consider as still likely. To complete my contingency plan, I would certainly size my positions progressively, by considering more significant exposure only if the stock would confirm its price level above the EMA200 on its daily chart, as well as breaking out from its EMA50 on its weekly chart.

SQ’s short interest has progressively decreased from its peak on January 31, 2021, now standing at 4.93%, and its short interest ratio stands at 1.93 days. While I don’t see the recent upward momentum being explained by short coverage, a further decrease of short exposure could likely be observed in case of a consistent breakout from the stock’s long-term downtrend.

With a likely risk-reward ratio of 3, I would build up a moderate position in SQ, and increase my exposure if the stock achieves to overcome the discussed milestones, leading me to rank Block as a buy position.

The bottom line

Technical analysis is not an absolute instrument, but a way to increase investors’ success probabilities and a tool allowing them to be oriented in whatever security is listed on the markets. One would not drive towards an unknown destination without consulting a map or using a GPS. I believe the same should be true when making investment decisions. I consider techniques based on the Elliott Wave Theory, as well as likely outcomes based on Fibonacci’s principles, by confirming the likelihood of an outcome contingent on time-based probabilities. The purpose of my technical analysis is to confirm or reject an entry point in the stock, by observing its sector and industry, and most of all its price action. I then analyze the situation of that stock and calculate likely outcomes based on the mentioned theories.

I am usually very careful with stocks that crashed as much as Block did in the past year. The problem with such a steep decline is the massive overhead resistance that the stock has to overcome before being set for a sustained and persistent rally. Other than this, it’s not uncommon that such a decline can lead buy-and-hold investors to their limit in terms of patience, as they could sell as soon the stock recovers to their break-even price or any price that psychologically seems a justified trade-off in exchange for getting rid of the painful sensation of a massive loss. As a general rule, I begin to consider stocks in a late stage 1 and preferably when breaking out into stage 2, but I sometimes observe stocks in their stage 4, especially when, like in this case, a breakout seems very close and the risk/reward profile is favorable. A positive outcome of my assumptions could lead to great gains, while the downside risk can be limited, leading me to rank Block as a buy position.