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Rrrrrational exuberance\?

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The GSTI Software Index (GSO.X) has come alive in recent sessions. Just in time for me to have turned bearish on share of sector bellwether Microsoft (NASDAQ:MSFT) $63.45 +0.2% last week at $58, when the stock looked to be breaking down and ready to embark on a final leg lower to $47, which was the bearish vertical count from the point and figure chart.

For day's since I had profiled the stock as bearish, "Mr. Softee" held strong on the $58-$59 level and Friday the stock started making some headway above the $60 level. Yesterday's trade at $63 was my stopping point for longer-term bears in the stock as the vertical count now turns bullish to $74.

Microsoft Chart - $1 box

Yesterday's "buy signal" was enough proof for me that the MARKET is just a little too bullish to be holding a tech bellwether as a short. Last week I was looking for the sell signal at $58 and bearish vertical count to be the sign that the stock was going to head down to the $47 level, which was a bearish vertical count for the stock. However, the stronger than expected economic data undoubtedly had bears running for cover and most likely some longer-term bulls accumulating the shares of Microsoft (MSFT). Instead of getting mad, we may well have gotten even, if not profitable, in a profiled bullish play in the software sector in shares of Rational Software (NASDAQ:RATL) $21.47 +5.86.

What Microsoft (MSFT) lacked in bullish technicals, was perhaps found in shares of Rational Software (RATL). Here was a stock in the software sector that was trading right on bullish support trend and looked to have just experienced a "normal pullback" to support. A trader short/put MSFT that wasn't finding any success (me, Jeff Bailey) was looking for a strong stock in the group with favorable technicals for a move higher. My thinking was, "if MSFT isn't going to crater for me, then a bullish move in the sector should have me looking long a technically strong stock for a move higher." This was somewhat of a "synthetic hedge" where a trader is long/call a software stocks and short/put another software stock. The idea is to trade long/call the technically "superior" stock, while trading out to plan the short/put technically "weaker" stock.

Rational Software Chart - $0.50 and $1 box

I hate losing money. When shares of MSFT continued to trade tough at the $59 level and not give up, we started looking for a software stock that would create somewhat of a "hedge" in the software sector. If MSFT was going to put together a rally off the near-term bottom, then no since letting that type of move that generally creates bullishness in the group go to waste.

From here, we want to see MSFT continue to show some gains and put together a rally to the $65-$66 level, and act like a tidal wave that helps create further bullishness in the software group. The key for traders I feel is to trade bullish in a software stock like Rational Software (RATL) that is showing relative strength versus the sector and has good supply/demand characteristics.

With MSFT still trading below downward trend (bearish resistance) any bullish positions would be early at this point. Usually I would only take 1/2 bullish position in a stock that is trading below bearish resistance, then add to the position once the trend were broken.

For now, look for shares of MSFT to rally near the $66 level, but have that potential action act as a tidal wave that brings greater bullishness to shares of Rational Software (RATL) and have that stock trader near the $25 level should MSFT achieve a near-term target of $66.

According to Dorsey/Wright and Associates, the software sector just recently reversed to 40% and is currently "bull confirmed" offer the bullish trader in the software sector an opportunity to trade bullish in a sector that is far from being overbought.

Jeff Bailey
Senior Market Technician
Option Investor

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