Buy Tesla (TSLA) On Oversold Conditions (Technical Analysis)

Tesla, Inc. (NASDAQ:TSLA) is currently the 14th largest component of the S&P 500 (SPY) with a market capitalization exceeding $350 billion. From its all-time high of $414.50, the stock has crashed over 70%. Although the stock appears likely to decline further over the next 6-12 months, present conditions are extremely oversold. This makes TSLA attractive for a short-term buy, and I would target $127 to $130 for a short-term bounce.

Clear intermediate downtrend intact

We can observe that the intermediate downtrend is getting stronger since the weekly Average Directional Index, or ADX, for TSLA is above 25 and rising. A rising ADX figure above 25 implies the prevailing trend is getting stronger. At the same time, price is ‘oversold’ according to traditional parameters for the weekly Relative Strength Index, or RSI. The last time weekly RSI reached a similar oversold condition was the 2019 bottom of $11.80. This does not necessarily mean that TSLA’s price is currently making a long-term bottom. Instead, it means the chances of a sharp counter-trend reversal are improving.

We can observe similar conditions in the weekly relative strength chart of TSLA versus the Vanguard Total World Stock ETF (VT). In the below chart, we can see that TSLA is even more oversold relative to the total stock market than its own price on an absolute basis. This confirms the degree to which the stock is oversold.

Signals from weekly charts are more likely to occur prior to a significant move in price compared to signals from shorter-term timeframes because signals from weekly charts occur less frequently.

Extreme oversold conditions in a daily timeframe

We can see that TSLA has reached an extreme oversold condition, with daily RSI at just 16.41. We can also observe a confirmed downtrend, given the rising daily ADX is well above the threshold of 25.

Extreme oversold conditions in the daily timeframe usually precede a sharp countertrend move. The more extreme the oversold condition, the more extreme the reaction is likely to be. However, such conditions do not necessarily mark a long-term bottom.

Another indicator that suggests we may be close to a countertrend reversal is the daily MACD. Although this indicator clearly shows an acceleration in downward momentum, the length of the histogram bars is currently shorter than the last major correction in October. This creates a bullish divergence that usually indicates that a countertrend reversal is close.

Major support at $113 and $93

TSLA has support at $113.22 according to a Point and Figure chart that uses a 4% box size and 3-box reversal configuration. Only a daily close below $108.87 would break this support level. This level coincides with a previous resistance level that TSLA broke on its way up to new all-time highs, which adds to the significance of this level.

If TSLA breaks the $113.22 support level, the next support level in this configuration would be $93.06. Given the sharp drop between the two potential levels of support, it makes sense to place a stop-loss in the $106 to $108 range to protect capital from another sharp drop in the share price.

Potential catalysts for a reversal

TSLA has over $15 billion in net cash on its balance sheet, which gives it considerable strategic flexibility for years to come. A potential catalyst linked to this significant cash pile would be a substantial share buyback. This would be a powerful signal from management that they believe the share price is extremely cheap.

It is important to note that some buyback programs turn out to be premature and result in the destruction of capital. Investors should therefore contextualize such decisions with the company’s valuation and prospects at the time it announces the buyback program. Given that TSLA is currently trading with a forward P/E of just 24x and a 5-year Price-to-Earnings-Growth ratio of just 1.08x, investors will likely interpret a large-scale share buyback program positively. An even more powerful signal linked to share repurchases would be significant insider buying in the open market.

Another decision from management that could support the share price would be initiating a regular dividend. A dividend yield of up to 2% is easily within TSLA’s capacity thanks to the strength of its balance sheet and free cash flow generation. The company currently has a free cash flow yield of approximately 2.4%, meaning a dividend yield up to this level is sustainable if free cash flow continues to grow. A regular dividend would open TSLA up to a new category of investors who exclusively seek dividend-paying companies or prefer to allocate most of their capital to dividend-paying companies. A regular dividend would also be a signal from management to investors that they expect the company’s earnings to stabilize and grow at a reasonable rate for the foreseeable future.

Finally, the company’s earnings call on 25 January 2023 presents the chance for management to provide one or more positive surprises to investors. This could be in terms of their guidance for revenues, margins, profits or production. Other announcements that could provide a positive surprise could relate to the company’s organizational structure or board of directors.

Trade set-up

Given extreme oversold conditions over multiple timeframes, traders seeking a compelling short-term trading opportunity could consider buying TSLA near its current support level with a take-profit target near the previous key support levels. A sensible zone for the stop-loss would be $106-108 since a daily close in this range would break the current support levels on which I am basing the set-up of this trade. The minimum timeframe for this trade should cover the company’s next quarterly earnings announcement.

• Ideal entry price: from $110 to $114
• Take-profit: from $127 to $130
• Stop-loss: from $106 to 108 (daily close)
• Timeframe: 10 to 32 trading days

Investors with longer time horizons could consider building a position in TSLA over the next three to six months, with the aim of maintaining an average cost in the range of $90 to $110. It seems likely that much of the concerns and hysteria creating the volatility in the share price will reach a positive resolution within that timeframe. However, investors should watch the $93 support level carefully because there is no significant support level thereafter until $60.

What could cause this trade to go wrong?

As I wrote in a previous article, there is a high chance that the global economy will endure tough, recessionary conditions in 2023 and possibly into 2024. The driving force for this difficult period is central banks from around the world tightening monetary policy into, at least, the first half of 2023. These recessionary conditions will likely have a negative impact on discretionary spending in most of TSLA’s key markets.

Rising policy rates could also cause long-term bond yields to remain high for the duration of the aggregate tightening cycle. High long-term bond yields make stock valuations more expensive since higher discount rates reduce the net present value of a company’s future cash flows. Companies like TSLA with relatively high rates of expected earnings growth and rich valuations compared to the broader market are especially sensitive to changes in discount rates.

Long-term bond yields rarely peak before the end of a tightening cycle, and it seems likely that the Federal Reserve will raise rates at least once in 2023. Nevertheless, it seems as though long-term bond yields peaked in 2022 given the falling trend of inflation in the US.

A possible silver lining from the recessionary conditions is that long-term bond yields should fall sharply once the Fed signals its intention to end its tightening cycle. This should reduce the downward pressure on the prices of high-growth companies like TSLA since discount rates are likely to fall.

Finally, a major headwind for TSLA is that equities in general are likely to face considerable pressure in 2023 due to a combination of tightening monetary policy, recessionary conditions around the world, and a possible widespread deterioration in earnings. TSLA’s 5-year beta coefficient (monthly) of 1.91 implies that it is likely to perform approximately twice as badly as the overall market in the event of a sharp market downturn if its beta coefficient remains constant.

Conclusions

TSLA is experiencing a historic drawdown and unprecedented oversold conditions. Momentum indicators suggest that downward momentum remains intact, so lower lows over the next 3 to 6 months are very likely amid dire macroeconomic conditions. In the short term, however, there are compelling technical signals indicating possible selling exhaustion. An oversold bounce could occur as bargain hunters build their positions and short sellers take profit. Given the precarious intermediate trend, it would be prudent to take at least partial profits at $127 since the ultimate bottom may not be in for TSLA.