A Tech Ratio Play

 | Jul 16, 2014 | 12:00 PM EDT
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While the Dinobots rose to seize control of the last Transformers movie, the Dino-techs are doing the same in the Nasdaq.

Intel (INTC), Cisco Systems (CSCO) and Microsoft (MSFT) posted strong earnings and have even stronger charts. I've been in favor of holding these stocks for some time. The move in INTC today, though, has me taking half the names off the table. I may regret it, but I just feel it is time. I am willing to give CSCO and MSFT a little more room.

Last night on Mad Money, Jim Cramer and I touched on two evolutionary tech names: Amazon (AMZN) and Netflix (NFLX). These heavyweights have been game-changers in their respective sectors, but it has been a tale of two techs this year with NFLX up more than 20% and AMZN down more than 10%. Unfortunately, given the time limits associated with television, we weren't able to get to all the charts.

With a chart that drew me to my conclusion, I felt Amazon might make a better long to a Netflix short (as a pair trade), or simply Amazon was the stronger chart in the short term looking at the ratio chart between the two stocks. I will say that these ratio charts work best with highly correlated names such as Exxon Mobil (XOM) and Chevron (CVX). When this is the case, you can play the chart for mean reversion similar to how some traders play the Volatility Index (VIX) when it becomes too stretched or too complacent. 

Comparing the ratio of Amazon's price to Netflix's price on the daily chart below, Netflix's recent dominance is clear. But that appears to have ended when July began. Amazon has been a strong outperformer and it looks as though it may continue. Based on the strong breakout in the Relative Strength Index (RSI), which foretold the price breakout we are seeing now, I believe this ratio will move up to the high 0.80s or even 0.90 from 0.79. That would mean Amazon runs to about $380 per share while Netflix falls into the $420s.

Amazon vs. Netflix -- Daily
Source: StockCharts.com

If we examine the same ratio in the weekly chart below, Netflix's pure dominance since late 2012 is evident. The ratio has fallen all the way down to 0.79 from 4.6. Some folks may point to the gap on the chart, but you could ignore it. Gap-fill is not a common characteristic in ratio charts, which do not have a high mathematical correlation. These names have a momentum and cult correlation, hence, the application of theory here. The long-term picture isn't quite as rosy for Amazon due to the bearish ratio price channel. Still, we see a breakout to the upside from a falling wedge within the channel, which is bullish and leads me to conclude we should at least test the top of the channel. Conveniently, the top of the channel is 0.90, which matches up very well with the daily chart.

Amazon vs. Netflix -- Weekly
Source: StockCharts.com

Furthermore, the time to be long Amazon and short Netflix against it has been near the bottom of the channel and while the CCI is moving above -100 from below it. This was the case at the beginning of July. The pattern takes several weeks to play out, so it is not too late. My preferred approach -- one I am pricing out today -- would be a long the AMZN call and long the NFLX put pair. I have no desire to be outright long or short shares in either name.

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