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Market Wrap

A Novel Concept: Profit Taking

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        04-23-2001        High      Low     Volume Advance/Decline
DJIA    10532.20 - 47.60 10571.00 10483.60 1.02 bln   1244/1818	
NASDAQ   2059.30 -104.10  2118.77  2046.84 1.84 bln   1456/2413
S&P 100   633.89 -  9.77   643.21   629.85   totals   2700/4231
S&P 500  1224.36 - 18.62  1242.36  1217.47           38.9%/61.1%
RUS 2000  461.07 -  5.64   466.67   460.35 
DJ TRANS 2794.13 - 67.17  2861.30  2785.71 
VIX        31.50 +  2.49    32.62    30.46
Put/Call Ratio      0.60

A Novel Concept: Profit Taking

The major market averages pulled back Monday in what appeared to be a natural reaction to last week's historic advance. Although the Nasdaq Composite (COMPX) shed triple digits in terms of points, the sell-off came on relatively light volume and with little conviction. Roughly 1.8 billion shares traded on the COMPX Monday, while just over 1 billion shares exchanged on the NYSE; the 30-day averages for the two are roughly 2 billion and 1.2 billion, respectively.

The catalyst to take profits, in the tech sector, was delivered by Joe Osha of Merrill Lynch. Osha, in a research note Monday morning, cut his intermediate-term ratings on several semiconductor companies, which included Intel (NASDAQ:INTC), Applied Micro Circuits (NASDAQ:AMCC), Vitesse Semiconductor (NASDAQ:VTSS) and PMC Sierra (NASDAQ:PMCS). Osha argued that there isn't any proof that fundamentals in the chip business are improving and that demand remains difficult to forecast. While Osha conceded that the Philadelphia Semiconductor Index (SOX.X) had most likely put in a bottom around 450 in early April, his bearish comments this morning were in stark contrast to what the famed chip analyst, Jon Joseph, said over a week ago. If my readers recall, Joseph issued bullish remarks on Intel and several other chip manufactures about two weeks ago, which set the SOX a light.

Now that Wall Street's sell-side is debating over the near- term future of the semiconductor sector, we can instead refer to price action in the chip space in search of clues. Prior to Monday's pullback, the SOX had ramped higher by nearly 50 percent in the space of about two weeks. That was obviously a very big move, and a little backing and filling is necessary following a ramp of that magnitude. What we need to do now is set forth a few levels in the SOX to monitor in order to either maintain a bullish stance or adopt a bearish stance, and trade accordingly. Furthermore, we can more easily manage risk by monitoring the levels I'm about to set forth in the SOX.

As my readers can see on the chart below, I've placed a retracement bracket on the SOX's recent move off of its relative lows at roughly 455, up to the 700 level last week. A pullback down to the psychologically significant 600 level makes sense, and would coincide with the 38 percent retracement level. I would expect the real buyers in the chip sector to defend long positions around the 600 level. Shortly thereafter, we'll find the 575 level, which marks a 50 percent retracement. A break below 575 might offer some quick, quality shorts in the chip space in terms of risk-to-reward. If traders were inclined to zero in on some shorts in the chip space, it might be most prudent to focus on the targets of Osha's downgrade Monday morning, such as PMC Sierra and Vitesse. A break below 575 will most likely lead the SOX down to 530, which might the downside target to cover shorts. Of course, the SOX could bounce off of any of the aforementioned levels, or possibly earlier, and negate Osha's comments Monday morning.

The reason I go into such detail with the SOX is because I think we can use it as an indicator for the Nasdaq, which was also due for a pullback. The first level I gravitate towards when looking for support on the COMPX is 2000 - I'm pretty sure I'm not alone on that! A pullback to 2000 in the COMPX might very well coincide with the SOX at 600, so we'll want to keep these two levels in mind this week. Below 2000, there's some serious congestion around 1900 - 1920, which could provide support should the COMPX break down below 2000.

As for the upside, the COMPX obviously has resistance around 2200. But, instead of chasing stocks up as they run through resistance, I think it's more prudent to scale in on pullbacks in this current market environment. I know that strategy wouldn't have worked last week due to Greenspan's gift, but I think it will work going forward. In short, for those readers looking to add exposure in tech, focus on the quality sectors and individual issues and look for entry points on pullbacks to support levels.

I would also like to point out the overbought condition of the COMPX as measured by stochastics. I used the default settings and you can see that fast stochastics (%K) rolled over last Friday and accelerated to the downside Monday. I normally don't monitor stochastics very closely, but I thought it would be prudent to mention the indicator at this juncture because of its overbought nature currently.

Away from the Nasdaq, the Dow Jones Industrial Average (INDU) bounced around the 10,500 level for the better part of trading Monday and managed to ramp higher into the close. The INDU was buoyed by old-economy types, such as 3M (NYSE:MMM), International Paper (NYSE:IP), Exxon Mobil (NYSE:XOM) and Caterpillar (NYSE:CAT). On a quick note, I think these types of stocks will continue to do well in light of the Fed's surprise move last week. Exxon Mobil is not as sensitive to interest rates as the other aforementioned issues, but it too continues to work higher. In fact, the majority of energy related stocks I looked at today had very compelling charts and continue to look strong, which may have been a product of the exceptional earnings report issued by Exxon Mobil this morning. Nonetheless, the energy group continues to trade very well.

In terms of technicals, the INDU has support at 10,500, which it tested several times Monday. The INDU did stage an incredible rally last week following the Fed cut, and I wouldn't be surprised to see the 10,500 level give way and see the INDU subsequently trade down to 10,300. The 10,300 level has been a significant site of support in the past, and I would expect the real buyers to step in near that level.

There were a handful of earnings announcements after the bell Monday, which are likely to impact trading and color market psychology Tuesday morning.

Compaq Computer (NYSE:CPQ) reported its first-quarter results, which fell short of consensus estimates by one penny. Shares of Compaq slipped by more than $1 in the after hours session, but other box makers such as Dell Computer (NASDAQ:DELL) and Gateway (NYSE:GTW) were only fractionally lower.

Novellus Systems (NASDAQ:NVLS), a chip equipment maker, reported earnings that bested estimates by one cent. Furthermore, its officials guided earnings estimates slightly higher for the next quarter, which is a good sign from where I sit! Shares of Novellus traded modestly higher in the after hours session.

In an interesting development, JDS Uniphase (NASDAQ:JDSU) said it would hold a conference call Tuesday to discuss what its officials called "important developments." It's unlikely to be an earnings warning because the company is slated to report its quarterly numbers Wednesday. The speculation was that JDS Uniphase would announce an acquisition. Nevertheless, shares of JDS Uniphase shed another $1.50 in after hours trading, which signaled to me that there's still some fear in the optical sector.

While the nervousness surrounding the mysterious JDS Uniphase announcement after the bell reinforces, to me, that there are some shorting opportunities in the tech sector, I think Monday's action was merely a regular pullback en route to consolidating the last two weeks of big gains. After all, the market doesn't go in a straight line. That said, the best course of action might be to wait for solid entry points off of support levels if readers are looking for bullish trades. Conversely, should support levels be taken out, such as the levels I outlined above, we can adapt and look to profit from the short side, which could very well happen in the short-term.

Aside from the possibility of profit taking and consolidation in the near-term, from where I sit, the market appears healthy and poised to trade higher over the intermediate-term. And, I have to admit, it feels good to be able to write about profit taking!

Eric Utley
Assistant Editor
www.OptionInvestor.com

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