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Rolling retracement for GSO.X

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The recent downward move in the software group has me rolling down my retracement bracket today for the GSTI Software Index (GSO.X). If you don't think this is important, then please go back and review the July 25th, 01:30 EST Update when we "rolled down" retracement on the Semiconductor Index (SOX.X).

GSTI Software Index Chart - last

Today I need to roll down my retracement bracket in the GSO.X to help determine some potential levels of support. I like the way our technique of "rolling retracement" fits the GSO.X and it gives our subscribers the upper hand on most retail investors. I believe here that market makers are net/short in their inventory and should be providing some support at current levels for many software stocks. The support could be temporary based on order flow at the trading desks, but it gives you and I some great levels to me monitoring and trading against. My thinking right now is that market makers are assessing risk to the downside at the 158 level and assessing risk to the upside at 61.8% retracement of 191.34. If I understand these levels from the market makers perspective and what he will be doing in his inventory positions for software stocks, then I'm much more confident in my trading of those stocks. The past two day's I've been mentioning (on several occassions) that traders should be considering a short/put position in shares of PeopleSoft (NASDAQ:PSFT). Now think about that 50% retracement bracket level at $175 on the GSO.X and see if the retracement bracket on PSFT gives hint to what market makers are doing and may be doing in coming sessions.

PeopleSoft Chart - last eleven months

We've had a "conventional" retracement bracket on PSFT from a relative high to relative low. Notice how the stock seemingly stopped near the $38.25 level today. This was right at the 200- day MA and the 38.2% retracement level. Do you see how nicely this action would now correlate with the 50% retracement level on the GSO.X.

My thinking is this. right now, PSFT is sitting right on a key support level, and I may have a lot of subscribers short/put this stock. What we want to see happen is for the GSO.X to continue lower below 50% retracement. Should that happen, then the probability of PSFT breaking the $38.25 is that much greater! At the same time, I am fully aware that a rally to GSO.X $191 (61.8%) retracement, could have PSFT rallying to it's rolling 50- day MA near $42.

Does this bother me? No. A rally in PSFT to $42 isn't a wonderful thought if you're short, but what a trader may have in his favor is that the GSO.X has a lot of overhead resistance. If the GSO.X has a lot of overhead resistance, then that has me thinking that a short in PSFT is still OK at current levels, but 1/2 position short/put above $38.25 is more appropriate currently than a full position short/put.

Should the GSO.X break below its 50% retracement and PSFT break below $38.25 at or near the same time, then I have conviction as a trader based on my observations to add to a PSFT bearish trade. Think like a market maker and what he/she is doing. Remember, a market maker MUST provide liquidity to the markets under any type of market condition. The only way they can do this is to monitor levels and inventory. When stocks and indexes break below levels, market makers are receiving too high of an order flow than their inventory position allows them to take in. Therefore, they must begin shorting stocks in the group that are breaking down, or at least selling away some long inventory that is moving against them. One order flow reverses to the buy side, they then adjust their market making activity.

Use this technique on other indexes and stocks you're trading. You will trade/invest with a much greater degree of confidence and conviction!

Jeff Bailey
Senior Market Technician

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