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Stocks holding higher ground

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Stocks continue to move higher today and some of the same groups that started showing some moves earlier in the week continue to pace the advance and this is a good thing in my book. All I want to do is to continue to monitor some of those observations made earlier and see if they hold. As long as they do, then I continue to trade per usual. As soon as I lose the leadership, I'm aware to a potential near-term change in posture.

Internets (INX.X) : On Monday, in the "market monitor" on OptionInvestor.com I thought shares of Yahoo! Inc. (NASDAQ:YHOO) offered the bullish trader a relatively low risk/high potential return trade near $11.50 as the Internet Index (INX.X) was bucking broader market action for the early part of the day. Shares of YHOO now trade $13.86 and have exceeded our preliminary bullish target for short-term traders of $13.53. I would want to be snugging up a stop under this trade under today's low of $13.44 at this point.

Yahoo Inc. Chart -

With YHOO getting above our first bullish target of $13.53, it's time to raise stops further. For five sessions, shares of YHOO have NOT traded below the previous day's low. In fact, the "inside day" of last Friday, helped set up the trade and give hint that the market was beginning to agree on price. It was after the stock broke above that inside day at $11.25 and the Internet Index (INX.X) continued to hold 3% gains that we felt comfortable with shares of YHOO at $11.50, with a stop just below retracement of $10.82. Our first target was $13.53. So far, the raising of stops below the previous day's low would have trader still holding the stock, so I'd stick with that technique. However, should the INX.X show any sign of weakness, then I'm willing to take a gain off the table. After all, it was the sector strength that had me looking at YHOO to begin with.

It was also the Internet Index (INX.X) that had us thinking there was still hope for a bullish rally in stocks. I've often written and still believe that this group is an excellent group for investors/traders to monitor. We know that the stocks in the group "lack fundamentals" or earnings for the most part, but bullishness is often times found when MARKET participants are getting aggressive on the "buy side." It's also a group that often times will show first signs of weakness, when the rest of the market begins showing signs of "irrational exuberance" thus giving hint of pending weakness for the rest of the market.

Keep an eye on the Internet Index (INX.X) to help monitor MARKET psychology and how aggressive or cautious it is.

Getting yourself "correlated" like a specialist

Yesterday in the "market monitor" on OptionInvestor.com I profiled a bullish trade in shares of Charles Schwab (NYSE:SCH) at the $15 level as the stock was breaking above a retracement level. The stock surged higher at the opening of trading this morning to the $16.15 level, but has since started pulling back. Here's what I think is taking place and a technique that traders might want to use with their retracement brackets.

Summary: I think shares of Charles Schwab (NYSE:SCH) are looking back over their shoulder at share of Merrill Lynch (NYSE:MER) and waiting to see if other stocks in the group are following it higher. Of course, this in only a comparison to Merrill Lynch (MER), but what we should be doing is using this technique of retracement to get a feel for where all the stocks in the group (or at least some of them) are trading relative to each other.

Merrill Lynch / Schwab comparison of retracement

I couldn't figure out why shares of SCH didn't run right up to its 200-day MA this morning at $16.80, so I started looking for clues. To be consistent, I wanted to look at some other stocks in the group, with retracement set to similar levels I had identified with Schwab (SCH). What I think I found is that SCH has just gotten a little too far ahead of Merrill (MER) on similar retracement. By anchoring both retracement from their relative highs on May 22nd and fitting the 50% retracement level BACK to the relative low prior to the May 22nd high, I'm now consistent and correlated as it relates to retracement. ALL of the other levels are merely a RESULT of this fit, but notice how the 80.9% retracement level did a pretty good job of marking the recent lows in September.

Institutional traders use this technique more than most individual investors learn from "conventional" retracement. It's how market makers and in the case of SCH and MER, specialists use retracement to monitor their risk. I don't know if the same specialist is trading MER and SCH, but if he/she is, then he may be somewhat bearish toward SCH today and more bullish toward MER. He can create a "synthetic hedge" in his book.

If a market maker or specialist has his/her retracement brackets anchored from levels that are not consistent, it becomes very difficult for them to control their inventory risk. They, like you and I, need to get things correlated and in unison.

Based on retracement, I'd rank SCH as a stronger stock than MER longer-term, but SCH most likely to show weaker results near-term unless MER can get above its 50% retracement and act like a wave to push SCH higher. This is also similar to domino theory.

From here on out, we could test each of these stocks against each other and easily monitor their levels against each other. This gives the trader a better feel for how things shape up.

Jeff Bailey
Senior Market Technician
Option Investor

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