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Slipping Into Some Software

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I classify 18 of the Nasdaq-100 ($NDX) components as software concerns. Those 18 stocks account for about 26 percent of the $NDX market cap. Microsoft (NASDAQ:MSFT) is the biggest component with its almost 11 percent weighting. Oracle (NASDAQ:ORCL) accounts for 3.5 percent. You can find the list of the 100 components of the $NDX as well as their weightings here:

http://dynamic.nasdaq.com/dynamic/nasdaq100_activity.stm

The fourth-quarter results from the software sector have been mixed. Microsoft disappointed with its report last week. The company said that its next quarter revenues would be lower than previously expected. Microsoft officials suggested that Wall Street's expectations for a strong recovery were too early and that roaring economic growth was far off. Microsoft is notorious for being conservative, so it's guidance has to be taken as such.

Oracle (NASDAQ:ORCL), who is not as closely tied to the Personal Computer (PC) market, was more bullish when it delivered its most recent financial guidance. The company's officials said earlier this month that Oracle's business had bottomed and '02 would be a better year. Since delivering its guidance, Oracle has assumed a leadership role in the Software Sector Index ($GSO), out performing its peers through today's session.

Rational Software (NASDAQ:RATL) was another that recently issued bullish financial guidance. The company reported two weeks ago that its business had stabilized and signs of a turnaround were visible. It stuck with its long-term growth target of 25 percent as well as reaffirming its guidance for this and next fiscal year. Rational, like Microsoft, is another that is considered a deliverer of conservative guidance. Like Oracle, Rational has assumed a leadership role in the $GSO.

Conversely to Oracle and Rational, PeopleSoft (NASDAQ:PSFT) issued guidance that was less than bullish during its report last night. PeopleSoft reported a good quarter, but its leaders failed to raise guidance for future and waxed cautiously on its business outlook. Like Microsoft, PeopleSoft down talked the possibility of a strong economic recovery this year.

The trading in the $GSO in the last two months has reflected the mixed fundamental front. Excluding an earlier period this month, the $GSO has traded in a range between 180 and about 195. The retracement bracket I currently use for the $GSO is anchored at last May's high, up around 246, and of course last September's low around 112.

The risk right this minute in the $GSO is unclear as the sector remains in its trading range. A breakout or breakdown below the respective retracement levels is tradable in my opinion, given the lengthy period of consolidation. But until the $GSO moves out of its range, in either direction, traders need to accommodate the prevailing sentiment, as well as employ bracketed market tools.

In a trading range, being bullish near support and bearish near resistance makes the most sense. If a breakout or breakdown finally occurs, a tight stop will minimize risk and allow a trader to reverse positions.

Moreover, oscillators are best employed in a trading range. The most popular choice is Stochastics. The set-up to look for is an oversold Stochastics reading near support, or an overbought Stochastics reading near resistance.

Jeff Bailey's profiled Microsoft position is a perfect example of trading range technique. The stock is at support, its bullish support line of the point and figure chart:

http://www.stockcharts.com/webcgi/Pnf.asp?S=MSFT&N=A&T=on

In addition, the stock's daily Stochastics reading is well into oversold territory. Here, the risk is easily measured and managed with a stop at or slightly below the bullish support line and the oscillator is revealing an oversold situation in which demand may resurface. Of course that's only speculation, but the beauty of Bailey's profile is how easily risk is measured and managed. (Just the reverse could be applied to a bearish profile, where a stock is trading near resistance and overbought by way of Stochastics.)

Jeff Bailey
Senior Market Technician
Option Investor

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