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Monday Mantra

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Goldman Sachs is the latest brokerage house to upgrade the semiconductor sector, and advised to clients to overweight chip stocks. According to Goldman, "data points are no longer universally negative, and fundamentals are likely to strengthen in the fourth quarter." ADI, MXIM, and LLTC were upgraded to a market outperform, and BRCM, CNXT, TUNE, and QCOM were upgrade to the recommended list. Intel is 80 cents higher in pre-market trading.

Stock futures are slightly higher this Monday, with the Dow up 14, and the Nasdaq up 17. HL Camp and Company has fair value for the S&P 500 at $3.31, with buy programs set at $4.57, and sell programs set at $1.85.

Friday afternoon in my market wrap on premierinvestor.net I wrote about entering today's trading with a negative bias toward software stocks and the GSTI Software Index (GSO.X). One stock I was specifically targeting with a bearish bias was PeopleSoft (NASDAQ:PSFT) on a break below the $38.12 level.

Since a trader never wants to enter the trading session with just a bearish bias, I should have a bullish bias also in place. This morning I'm entering the trading session with a bullish bias in the semiconductor sector and specifically shares of Vitesse Semiconductor (NASDAQ:VTSS).

Semiconductor Index Chart - last four months

I believe that market makers currently have a "buy side" bias for semiconductor stocks. My belief comes from the hard work we did on July 25 with retracement when we were rolling down retracement in the 01:30 EST update and had identified a potential level of market maker support at $528.66. At that time, the SOX.X was falling fast and traded $535. In the next 2.5 hours, subscribers were amazed that the SOX.X continued to fall to 530.86, then reverse course and finish the session at 553.34. Six sessions later, the SOX.X had risen nearly 23%. It makes sense to me that market makers must have had a bullish bias at the 530 level which we had identified as a potential level of market maker support, but that doesn't mean they had a bullish bias after a 23% run to 0% retracement at $653.

Now look what took place on Thursday and Friday of last week. Hmm... looks like some buy side bias coming in at 38.2% retracement. This is exactly what a market maker would be doing as he works his inventory and gets it adjusted properly. Bullish at a bottom, bearish at a top and getting neutral in between. All of this based on the market makers feel for order flow and simply trading levels to assess risk in their inventory.

I've added two "new" levels of retracement to try and help us out near-term. The 19.1% retracement at $615.21 is only a level by which I want to have in place to give me a feel for where a market makers bias may change to a more bearish level. Lets face it, the recent upward move from July 25th and 23% move higher from there didn't come because market makers were holding excessive inventory. Those that sold the strength from 615-653 (on the up and down move) should now have a buy side bias to the group. Here's a stock I've written about in depth recent weeks. Nothing new here. Again using retracement bracket to try and sniff out market maker support. I think the 60-minute interval is interesting and gives the trader excellent correlation between the SOX.X and how a market maker is trading shares of VTSS.

Vitesse Semiconductor - 60-minute interval

The 60-minute chart of VTSS and retracement gives hint the VTSS should have a bullish bias from market makers at current levels. For the short-term and swing trader this is important for initiating a bullish position and identifying a stock as a bullish trade candidate. Every trader should have a list of bullish and bearish trade candidates before every trading session. I like the correlation of retracement to the Semiconductor Index (SOX.X) as it gives the trader a good feel of levels to be trading as it relates to the broader index itself. It also gives firm proof of how market makers trade levels. The sector is nothing more than a reflection of the stocks that belong to the group. Right now, I'd say that VTSS is trading in line with the semiconductor sector.

Here's another "new" thing I'm showing traders as it relates to volume. On Q-charts, you can actually have the volume bars reflect up and down volume by differentiating color. What this does is give you a feel for how a market maker is adjusting his/her inventory.

For example, one could say that at point (A) the market maker received a large order from an institutional client to "buy 2,000,000 shares at the open net $21." The market maker having that in his/her inventory gladly filled the institutional order at the open (at $0.02 per share or $40,000 commission) and then replenished inventory and stock moved higher. Once stock reached upper end of range (correlated with fitted retracement of SOX.X) market maker adjusted inventory and sold strength as buy side order flow was diminishing (lots of red volume bars). Did you know that a market maker can actually only show just 1,000 shares on the offer and trick level II traders into thinking he doesn't have much stock to sell? It's done all the time and an inexperience level II trader is easy money for a market maker.

Point (B) I think shows a market maker adjusting his/her inventory from a previous over-short position. It makes sense that a market maker trading levels properly that shorted inventory from $23.35 - $21.81 locked in some inventory gain and got things square. Since there was very little volume (red bars) the market maker took offers from other market makers with properly adjusted inventories.

Points (C) show lesser volume as inventories become more in line and the stock calms down. A short-term trader is monitoring up vs. down volume bars and begins to see more of a buy side bias and settling in the stock right at 61.8% retracement of $18.39.

Trade set up. The reason I have a bullish bias more toward VTSS than perhaps some other stocks is that this stock recently have the bullish triangle pattern buy signal and has now retreated back into that base. The explosive move out of that triangle formation at subsequent 26% move correlates wonderfully with what we saw in the Semiconductor Index. I've drawn some thick red lines on the chart that show the bullish triangle and I've extended a horizontal line from that triangle to represent the apex of the triangle.

Should the market have a "buy side" influence today (I'm writing this Saturday evening), I'd have shares of VTSS on my bullish candidate list. If futures are trading lower in the morning, be patient with the stock and try to get it as cheap as possible. Watch the group at the open and watch the stock. Should things get carried away to the upside and the stock trade near the 19.1% retracement of $21.81, think about selling the August $22.50 call (.VQTHX).

Jeff Bailey
Senior Market Technician

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