Rare chart pattern setting up 3 stocks for upside trade

Key Points

• Axon, MercadoLibre and e.l.f. Beauty pulled back in the first week of the year after forming three-weeks-tight trading patterns.
• Though infrequent, this pattern may signal potential gains, offering a springboard for an upward price move.
• These and other strong stocks may simply be pulling back along with the broader market on algorithmic trading. 

Axon Enterprise Inc. NASDAQ: AXON, MercadoLibre Inc. NASDAQ: MELI and e.l.f. Beauty Inc. NYSE: ELF all traded lower along with the broader market in the first week of the year, but a little-known trading pattern could indicate these stocks may be setting up for gains.

The three-weeks-tight trading pattern is a technical analysis concept that isn’t as well known as some others and doesn’t occur as frequently. However, when you see that, it could offer a springboard to a price move to the upside. 

While trading patterns broke down the week ended January 5, after many leading stocks posted stellar returns in 2023, it’s still worth watching those with strong fundamentals and clear institutional support.

Axon, MercadoLibre and e.l.f. Beauty meets those criteria, as well as having the three-weeks-tight pattern in common. 

What pushed stocks down in January

Before digging into each of those stocks, let’s take a look at broad market action in the first week of 2024. 

While 2023 ended with much jubilation about possible rate cuts this year, investors seem to have sobered up after the end-of-year party, curbing their rate-cut-related enthusiasm.

This is why it can pay, literally, to focus on other markets besides equities. The bond market is offering some clues about current sentiment. The 10-year Treasury yield is hovering around 4%. That’s still lower than it was in late October, when a downward trend began, but it’s noticeable that yields are turning higher again.  

A better-than-expected jobs report contributed to renewed pessimism about rate cuts, and a Barclays downgrade of Apple Inc. NASDAQ: AAPL set the tone for investors to be wary of other high-flying techs, such as market leader Nvidia Corp. NASDAQ: NVDA and other technology stocks.  

Several factors behind downside trade

The current downside trading is likely a combination of several factors, including profit-taking after the big 2023 run-up; paring back individual positions on concerns about interest rates or factors such as slow smartphone sales, as cited by Barclays; or algorithmic trading, in which a basket of stocks or an index sell off on pre-determined technical signals. 

Growth stocks such as Axon, MercadoLibre and e.l.f. Beauty, or techs and consumer discretionary stocks in general, tend to benefit from a lower-rate environment. Developments like a better-than-expected jobs report led traders and investors to believe rates may remain higher than they expected just a week or two ago. 

But does that mean you should write off stocks whose patterns broke down along with the broader market? 

Not necessarily. It’s not uncommon for even the market’s biggest leaders to undergo some selling when the broad market pulls back, and profit-taking after big rallies is also normal.

What is a three-weeks-tight pattern?

So why is the three-weeks-tight pattern, in particular, worth watching? 

This pattern occurs when a stock consolidates within a narrow price range for at least three weeks. During this time, the stock's price movements are limited, forming a tight pattern on the chart. This consolidation is essentially a holding pattern; you can think of it like a coiled-up spring right before it’s set loose. 

The three-weeks-tight pattern is also an indication of institutional support.

Axon holding above 50-day line

Take a look at the Axon chart. The maker of public safety and other security hardware and software began a strong rally in August. The stock rallied 8.29% the week ended December 15, then held steady in a narrow zone for the rest of the month. 

Although it’s pulling back along with the broad market, Axon stock is holding well above its 50-day moving average. 

Latin American stocks outpace U.S. indexes

The MercadoLibre chart shows the stock pulled back to its 50-day line after retreating from a three-weeks-tight pattern. You can spot some investor optimism on the Latin American e-commerce retailer’s chart, as the stock has been trading higher for the past two sessions, defying the broad market pullback.

Worth noting: The iShares Latin America 40 ETF NYSEARCA: ILF was showing better gains on January 5 than U.S. markets, suggesting a divergence in investor sentiment regarding the regions.

e.l.f. outperforming small-cap index

Finally, the e.l.f. Beauty chart also shows upside trade on January 4 and 5, outperforming the SPDR Portfolio S&P 600 Small Cap ETF NYSEARCA: SPSM, of which it’s a top component. 

The stock regained its 5-day and 10-day moving averages with the end-of-week bounce.