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Good looking rally underway

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I really like what I'm seeing this morning in the markets for a good looking session for the bulls. YIELDS are higher, Biotech's are leading the charge (I wanted to see biotechs continue their leadership) and Fannie Mae (NYSE:FNM) is falling.

Fannie Mae (NYSE:FNM) is a stock I wanted to see fall as it gives me some hint that there's a MARKET bias toward a higher YIELD in the bond market and near-term, we might see some refinancing of mortgages begin to fall off. A trader may also want to have a partial hedge for their account since we continue to get some "anthrax scare" from time to time and there is still threat of terrorism. While I'm not necessarily wanting FNM to fall due to anthrax/terrorism, I must be a realist and understand the type of market environment I'm trading/investing in.

Fine-tune your retracement

Over the past year, I've been teaching traders the "art" of fitted retracement and rolling down retracement. This morning I got an upside alert on the Morgan Stanley High-Tech Index (MSH.X) and when I pulled up the chart, I felt I needed to re-fit my retracement somewhat. Here's what I'm doing.

Morgan Stanley High-Tech Index Chart -

When I pulled up the chart of MSH.X as it gave me an upside alert at $456.66 this is what I saw. I've labeled different levels on the chart and begin the thought process of how a trader may have used the levels of retracement to have successfully profited from recent trading. The first thing that stuck out was how the bottom of the MSH.X trading didn't quite achieve my 80.9% retracement of $342.93 as the "double-bottom" low came at $349. I might want to "re-fit" my retracement to reflect that level. After all, the MARKET was trading that level as a reversal level and I now want my chart to reflect that level of demand outstripping supply. I've also added the ?? as a potential "bull alert" type of thinking. Over the decline of the MSH.X we've seen a level of retracement violated to the upside, but never two levels like we're seeing today. Here's what my "fine tuned" retracement on the MSH.X will look like going forward.

Morgan Stanley High-Tech Index (Adjusted retracement)

The above retracement more accurately reflects how the MARKET my be trading levels of retracement on the MSH.X. Notice how we've kept some of the past integrity of the levels during the decline, but now we have perhaps found the "true" levels of retracement that identified the bottom near $348. Now we have some levels to begin laying out levels to monitor. A bull now wants to see a break above the 460 level to get a more comfortable feeling that there is truly a rally underway.

How can we test?

My scenario has been and remains, HIGHER bond YIELDS and Biotechs leading in strength. These are two ingredients I want to see based on observations of strength beginning to build in late September. So far, biotechs have shown greater relative strength and my scenario continues to unfold, but I must keep putting my trading scenario to different tests and establishing levels of resistance to monitor for breakthroughs.

I must also constantly be "fine tuning" my retracement levels. Remember, during the decline, we were rolling down retracement to provide levels of resistance by which we would monitor any upside risk in our bearish trades. By rolling down retracement brackets, we were identifying POTENTIAL levels of support as our bearish targets where we might want to cover some bearish trades and lock in profits. Not all "fitted" retracement levels end up being what the MARKET was trading. Trading is a dynamic and never static.

Check the levels you're trading against what the MARKET appears to be trading. This will keep you in better-tune with the market and increases your probability of staying on the right side of things.

Jeff Bailey
Senior Market Technician
Option Investor

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