On Monday I will miss what I feel could be one of the most
exciting and profitable trading days in recent weeks. The
direction I am uncertain about, but it should not matter as I
will enter Monday's trading with a bias.
My bias going into Monday is that software stocks will trade
lower and that Semiconductor stocks will trade higher. The rate
of change (up or down) will only be affected by broader market
direction.
The two stocks that I would be looking to trade is PeopleSoft
(NASDAQ:PSFT) short/put and Vitesse Semiconductor (NASDAQ:VTSS)
long/call. Here are the reasons why.
Let's start with the software sector as depicted by the GSTI
Software Index (GSO.X) and PeopleSoft (NASDAQ:PSFT).
GSTI Software Index - last seven months
I call it rolling retracement. Recently I had to "roll down" my
retracement bracket on the GSO.X as the index broke recent
relative lows and I needed to try and figure out just what in the
heck a market maker is doing with software stocks he makes a
market in. I anchored retracement to $244.69, then "fit" the
38.2% retracement under a relative low (July 11th at $191.35
seemed smart as the GSO.X did an about face higher from that
level so there had to be buyers there). Once that $191.35 level
was violated to the downside, it makes sense to me that market
makers began taking a defensive posture toward software stocks as
sellers outnumbered buyers and a market maker carrying bullish
inventory now had risk to the rolled down 50% retracement level
of $174.88. Hey! That's pretty close to where the GSO.X found
some support today! That makes sense. If a market maker played
defense at $191.35 on the break of that level, then that means he
probably sold strength on the rally back above $191.35 (about 8
days). When he "sold strength" he could have been getting rid of
some bullish inventory and at the same time shorted some stock at
or above $191.35. Today, some of that stock he shorted at
$191.35 was bought back. Good thing he was short, because there
were a lot of sellers today in the software stocks! Oracle
(NASDAQ:ORCL) traded down 5.19% and traded 61.7 million shares.
How could a market maker provide liquidity for that amount of
stock if he didn't already have a big short position? What do
you think could happen Monday if the GSO.X breaks below 50%
retracement at 174.88 and closes there? If I'm a market maker,
I'm thinking my next downside level of risk is 61.8% retracement
near the $158 level. This is how a market maker controls his
risk in his/her inventory. What could cause this type of
decline? BEA Systems is scheduled to report earnings on Tuesday
after the bell and some analysts think the company will guide
lower in their conference call. Since BEAS hit a 52-week low
today and traded down 8.5%, I figure the market already knows the
bad news there. But that sets up an opportunity for "bad news"
in the software group to perhaps create a catalyst for another
downward move. Should the GSO.X break below the $174 level on
Monday, I can use that as a hint of further weakness coming.
Perhaps Tuesday's new bearish play in PeopleSoft (NASDAQ:PSFT) at
$42.38 is starting to make sense with the stock finishing today
at $38.84 (-4.59%)! Check this out, and this is what to be
looking for on Monday, Tuesday and then Wednesday morning after
the BEAS earnings.
PeopleSoft Chart - last 10 months
I love the correlation set up between retracement on the GSO.X
and what we saw take place in shares of PSFT today. If my
earlier "scenario" of market makers recently getting short some
software stocks on the breaking of retracement in the GSO.X, then
subscribers that took Tuesday's profiled short in PSFT are
looking good and are right in the thick of things. What traders
want to see Monday or Tuesday is a break below the 38.2%
retracement level of $38.24 in PSFT and a break below the 50%
retracement of $174 in the GSO.X. If they both happen
approximately the same time, then the trader really gets the
feeling he's in there with the market makers and playing their
game. If you're thinking like a market maker and you think the
downside in the GSO.X short-term is $158, then we can correlate
that type of thinking with some levels in PSFT.
Right now, a trader that is short PSFT at $42-$38 is targeting
$34.31 as a potential market maker support level. If that is
broken to the downside, then upward trend near $32 might serve as
support. If that is broken then the $30.37 level might get
tested. Regardless, a trader that is short from $42-$38 might
look like a big cat, wearing a smile, and yellow canary feathers
protruding from the sides of his mouth. It's never over until
the trade is closed for a profit. Right now, I'd have my stop
set at break-even for the trade. Traders still looking for a
good short candidate can still take action on a break below
today's low of $38.12. If the GSO.X breaks first, then all the
better. Simply looks for PSFT to then confirm that move in the
GSO.X with a break of its own.
How to close the trade. Stops should be honored and not
questioned. The only question remaining is how do I lock in my
profit? My answer to that is simple. Don't get greedy and try
to "sell early." If you would be happy with locking in a gain on
a break to the $34.31 level, then immediately buy back your short
if the stock trades that level.
If you are short 300 shares and the stock trades near $34.31,
think about doing this. Cover 100 shares near $34.31. Then put
a stop on the remaining 200 shares at $38.24 (previous stop was
$42, so don't forget to cancel that old order) If the stock
trades at upward trend near $32, buy back another 100 shares at
$32. Once that is done, cancel the previous stop order on the
remaining 100 shares, and replace that order with a stop order to
buy back the last 100 shares at 50% retracement of $34.31. If
the stock trades $30.71 before your stop is hit, then cancel the
stop order and buy back the last 100 shares short. Your done and
you didn't have to guess where to lock in a profit. It was all
very systematic and there was no guesswork involved. You let the
stock do all the work for you and the market made all the
decisions.
Does this sound stupid? Hopefully not. It is very much the
systematic way a market maker controls his inventory. He does it
with levels.
Now, the previous example used for 300 shares was just that. An
example of how to trade a position. Some traders only trade 100
shares and that is fine. If the commissions don't eat you up,
you could split 100 shares in lots of 33. If you traded or are
going to trade 1,000 shares you can use the same systematic
approach. Always try and lock in some type of profit early
though. I love the trade set up for a coming move lower in PSFT,
but I have no way of knowing for certain that the scenario
outlined above will come to fruition. If it does, then fantastic
and we all have a plan in place, levels identified and we're set
to go on Monday. Let the stock tell you what to do. Have a
great weekend.
You will be in the very capable hands of Jeff Canavan and Jon
Farnlof on Monday. Monday morning, Mr. Canavan will talk about
the bullish trade setup in the semiconductors and Vitesse
Semiconductor (NASDAQ:VTSS). We'll be using the exact type of
retracement techniques used above. You will be amazed why the
semiconductors acted the way they did today and why a trader will
want to go into the session with a bullish bias. Should the
broader market trade higher on Monday, then I'm thinking this
group could be the standout.
Final note. Always try to enter a trading day with a bullish and
bearish trading scenario. That way, regardless of market
direction, you will have some type of plan in place to make
money. Heck, sometimes a very good plan and scenario even works
regardless of market direction. Why was PSFT down 4.59% today,
even though the NASDAQ Composite was down just fractionally and
the GSO.X was down just 2.67%? I'm not sure I need to know as
long as I'm trading levels and constantly monitoring the
risk/reward against those levels. It's always nice to know "why"
something is happening. Unfortunately, once the news has been
made public, the bulk of the move has usually been realized.
Time will tell, but hopefully you can use some of the techniques
shown above to your advantage in other trades you're looking at.
Have a great weekend!
Jeff Bailey
