Gap Plunges on Earnings - Here's How to Trade the Stock

Gap is plunging about 20% after reporting disappointing earnings. Let's consult the charts to see if this is a dip to buy.
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Shares of Gap  (GPS) - Get Report were getting hammered on Wednesday, down about 20% on the day.

The decline comes after the company reported disappointing third-quarter earnings.

Profit of 25 cents a share sank from 37 cents a share a year ago, while revenue growth was flat year over year and came in at $3.99 billion. 

While a 61% jump in online sales was good, same-store sales still plunged 20% from the same period a year ago.

Given some of the numbers that we’re seeing out of other retailers, like Dick’s Sporting Goods  (DKS) - Get Report with its strong quarter or Dollar Tree  (DLTR) - Get Report with its move to new 52-week highs, the quarter from Gap was uninspiring.

Further, the stock was simply up too much heading into the quarterly report..

Gap stock was up more than 400% from the March lows and at its highest level in more than a year going into earnings. 

While the post-earnings dip is notable, it’s not the end of the world considering some of these observations. Let’s look at the chart.

Trading Gap

Daily chart of Gap stock.

Daily chart of Gap stock.

The decline has already resulted in at least one analyst downgrade, after Citi lowered its outlook and cut its price target from $30 to $27. Still, that represents about 25.5% upside from current levels.

The question now is whether Gap stock can hold support.

For months, Gap has been trending higher in a channel (blue lines) in a very orderly fashion. Right now, it’s declining right into channel support.

For longs who really like this name, Wednesday’s drop could be their buying opportunity. For me, I have a hard time getting too excited about this drop, given the severity of the decline.

If support holds, look for Gap stock to rotate back over Wednesday’s high at $22.88. That's a setup I would like more, because we would at least have a defined risk level (that being the post-earnings low). 

Above Wednesday's high and shares can start filling in the post-earnings gap, as bulls look for a retest of the 10-day moving average.

Should a multi-day decline be in the works, look for Gap stock to test down into the 50-day moving average. This level has guided the stock higher for months now, even though it hasn’t actually tested it.

I hate to sound too conservative, particularly on a retail stock with a strong trend going into the holidays. However, could we be looking at a larger washout?

If that’s the case, I would be targeting the $18 to $18.50 area. Not only does the 100-day moving average come into play near this mark, but it’s the prior 2020 pre-coronavirus resistance level.

This zone was been both resistance and support (in that order), with shares pushing through it in October. I don’t know that we’ll decline that far — who knows, perhaps channel support will hold after all — but if it does, this area should support Gap stock.