How to Trade Cisco’s Earnings Flop

Cisco is down - but not out - following earnings.
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Tech giant Cisco Systems  (CSCO) - Get Report was getting attention for all the wrong reasons Thursday. Cisco’s getting swatted lower - down more than 6% - on the heels of a quarterly earnings that failed to impress investors.

Excluding one-time items, Cisco reported earnings of 77 cents a share for the quarter, slightly besting analysts’ estimates of 76 cents. The company also hiked its dividend to 36 cents a share, implying a forward yield of 2.88%.

Despite the beat and raise for income investors, the reaction in the market Thursday wasn't good.

But while Cisco may be down Thursday, it’s not out just yet. In fact, the earnings reaction may be setting the stage for a meaningful move higher in the weeks ahead.

To figure out how to trade Cisco’s earnings reaction, we’re turning to the charts for a technical look.

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At a glance, it’s been a rough couple of quarters for Cisco.

Shares have shed around 10% of their market value over the trailing six months, a track record that’s all the uglier when you consider the fact that the rest of the S&P 500 has charged 16% higher on a total returns basis over that same timeframe.

Still, Cisco’s stock price is showing some signs of life in 2020.

Specifically, shares have spent several months carving out a pretty textbook example of an inverse head-and-shoulders pattern, a bullish reversal setup that signals exhaustion among sellers.

The setup in Cisco is formed by a pair of swing lows with a deeper swing low in between them - and the buy signal comes on a breakout through Cisco’s neckline, currently at the $50 level.

Don't let the silly name fool you; the head and shoulders is an effective trading setup. An academic study conducted by the Federal Reserve Board of New York found that the results of 10,000 computer-simulated head-and-shoulders trades resulted in “profits [that] would have been both statistically and economically significant.”

While shares’ earnings reaction prolongs the wait for this big stock to break through its $50 neckline level, the important thing here is that the selling is holding support at the $46 level that defines the right shoulder. As long as that level holds, this long-term pattern remains in play.

Aggressive traders should consider building a starter position on a bounce off of support here. More risk-averse investors may want to wait for the $50 breakout, which indicates that buyers are definitively back in control of things.

Either way, a move through $50 in Cisco clears the way for a test of prior highs above $57.

Cisco’s earnings reaction may not be what bulls were hoping for, but the longer-term picture still looks constructive for this big tech trade.