Bloodbath in Pot Stocks Presents Strong Risk/Reward Opportunities for Contrarian Traders

Sell-Off in Marijuana Stocks Was Overdone

To say pot stocks have been under pressure is an understatement.

In February, marijuana stocks were flying high after traders from the “Reddit” forum “WallStreetBets” pumped up the pot sector with frenzy buying. Those investors powered pot stocks to some of their highest levels since the legalization of recreational pot in Canada in October 2018.

But the growth path for marijuana companies has been riddled with bumps, including disappointing sales, regulatory issues, and the COVID-19 pandemic.

While the U.S. has seen a steady move toward legalization or decriminalization of pot at the state level, we’re still waiting for the decriminalization of recreational cannabis at the federal level. If this does happen, it would drive significant growth in the pot sector.

For now, the stock market has adopted a wait-and-see approach as pot companies focus on ramping up their sales while providing a pathway toward positive earnings before interest, taxes, depreciation, and amortization (EBITDA), as well as consistent profitability.

Technical Picture Shows Strong Upside for Pot Stocks

The ETFMG Alternative Harvest ETF (NYSE:MJ), a barometer of the major players in the marijuana sector, has been under steady pressure since declining from the Reddit spike in February.

The ETF’s major holdings include Aurora Cannabis Inc (NASDAQ:ACB), Canopy Growth Corp (NASDAQ:CGC), Cronos Group Inc (NASDAQ:CRON), GrowGeneration Corp (NASDAQ:GRWG), and Tilray Inc (NASDAQ:TLRY).

Marijuana stocks are down by as much as 80% from their 52-week highs and are worth a look for contrarian traders.

After trading as high as $45.40 in September 2018, just prior to the legalization of marijuana in Canada, the ETFMG Alternative Harvest ETF declined to $8.81 during the stock market sell-off in March 2020.

In February 2021, the ETF rallied by 292% to $34.58.

But after that upward move, ETFMG Alternative Harvest ETF has been in a steady decline, driven by weakening relative strength and a bearish moving average convergence/divergence (MACD).

In the process, the ETF broke below several support levels above $20.00. The break below $20.00 has proved bearish. The ETF failed to establish a firm base, breaking below a key $11.50 support level to a new 52-week low of $11.26 on December 3.

Chart courtesy of StockCharts.com

Pot stock investors must be careful in the immediate future. There’s no firm bottom or base forming in the marijuana stock market.

The above chart shows a firm downward bias with the ETFMG Alternative Harvest ETF in a death cross, a bearish technical crossover pattern that appears when the 50-day moving average breaks below the 200-day moving average. Technically, this supports a bearish outlook.

Traders now want to see oversold buying, which has so far eluded the pot sector. Its relative strength remains extremely weak, and for pot stocks to deliver any sustainable upside moves, it must improve.

The positive news is that the upside could be significant. The Fibonacci retracement levels show that the first major target is just over $18.00, followed by $22.50 and $26.00. The key downside risk is $10.00. 

Analyst Take

While the near-term technical picture for marijuana stocks looks bearish, the fact is, there are aggressive opportunities for patient investors.

Given that most pot stocks have corrected toward their 52-week lows, it might be time for investors to begin accumulating shares of individual beaten-down marijuana stocks or the ETFMG Alternative Harvest ETF.

The future still looks bullish for the marijuana sector.