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Internets lead sector gainers

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The CBOE Internet Index (INX.X) leads our sector gainers list today with a robust 12% gain. Action here hints of continued short-covering and a market that is starting to get aggressive on the "buy side." The break of downward trend on October 4th was early alert that some strength was starting to occur. Action at the $93 level was also a break above our 61.8% fitted retracement.

CBOE Internet Index (INX.X)

Any bears caught short in some internet related stocks are currently assessing risk to the 120 level. A break above there could see a surge to 148 as shorts rush to cover. Current risk for a bull would be to the $93 level. Note how this index has had a tendency to trade very well off of our fitted retracement.

I'm caught short in eBay at $46

One of our subscribers got caught short in shares of eBay Inc. (NASDAQ:EBAY) at the $46 level and is feeling some heat. If you trade long enough, you will eventually feel similar heat. Your first short-squeeze often times becomes your last. I know, I've been there and done that in Amazon.com (NASDAQ:AMZN) back in October of 1998 near the $20 level. You know... stocks overpriced, trades at high multiple, Russian banking crisis and economic slowing here in U.S. Trouble was, market didn't agree with my analysis on Amazon.com back then as the stock rocked from $20 to $100 by January of the next year. Fortunately, I called it quits (me and my clients) when the stock broke to new highs at $25.

I'm not writing this to rub salt in anyone's wounds that might be short in shares of eBay (NASDAQ:EBAY), but we must face the facts that sometimes it takes awhile for the MARKET to figure out what we already know about stock price valuation. In brief, stocks don't always trade off of current valuation, but perceived valuation and we must control our risk and admit our mistakes at certain levels in order to trade another day.

Let's take a look at eBay (EBAY) and see what we can do. It's never too late.

eBay Inc. Chart - $1 box

Quick review shows that EBAY had was getting close to achieving a bearish vertical count of $47 just prior to terrorist attacks on September 11th when the stock was trading $54. Then on September 17th, when stocks resumed trading shares of EBAY fell to a session low of $49.20. Over the next couple of sessions, broader market averages continued their decline and investors started dumping stocks and shorts came in with abandon. The first sign of trouble for an EBAY short came at $49 when the stock gave a double top buy signal and things have just gotten worse. Today's trade at $58 was enough to get the stock above bearish resistance and now puts stock on bullish trend.

I've tried to identify certain levels where we could see a pullback, but bearish traders have been looking for a pullback since $49 and haven't gotten it yet. If I were short at $46, I'd see it as a gift if the stock would pull back to $50, let alone the $54 level. The spread quadruple bottom that was broken in August along with bullish support at $59 was bearish for EBAY and I'd expect some shorts that shorted that breakdown and covered at the bearish price objective of $47 to be coming back for seconds with a stop just above at $63. Thinking this way give the trader short at $46 something to think about. The thought.... "if the stock trades $63 and gives another buy signal, I've got to call it quits or be hedged for a break above there.

We've had retracement on EBAY from $71.11 to $27.93, which has correlated will with the stock (up and down). The 19.1% retracement level at $62.86 correlates with the point and figure chart at $63. The 38.2% retracement level resides at $54.61 and 50% retracement is at $49.52.

Relative strength

More bad news for a short here. Relative strength chart gave a point/figure buy signal today after chart had reversed into column of X's in early October. This tells us stock now outperforming market (S&P 500).

Hedge Strategy

At some point, a trader that is short a stock where it is moving against them must have a level in their mind where they call it quits. If $63 is our level to call it quits, then I'm looking at the Oct. $60 call (QXBJL), which is offered $2.70. This option expiration would have the trader having to make some type of firm decision on the stock come next Friday (Oct. 19th). The Nov. $60 call (QXBKL) is offered $5.30, but I'd now be cheating away from my $63 "call it quits" level.

Jeff Bailey
Senior Market Technician
Option Investor

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