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Daily Newsletter, Thursday, 02/14/2008

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Table of Contents

  1. Market Wrap
  2. New Plays
  3. In Play Updates and Reviews

Market Wrap

Market Wrap

New report format tonight--I'm trying a new format for tonight's newsletter in an effort to make it a little easier to read. These reports tend to get a little long and your time is valuable. Feel free to provide feedback on what you like and don't like (I'll probably be trying a couple of different ideas to make it easier for you to find the information you want to focus on).

Wednesday, February 13, 2008

Slippery Slope of Hope


1.0 Overview

1.1 Markets at a Glance--Corrective Bounce
1.2 Hope-filled Rally
1.3 Economic Reports

2.0 Equities

2.1 S&P 500 Index (SPX)
2.2 Dow Jones Industrial Average (DOW)
2.3 Nasdaq-100 Index (NDX)
2.4 Russell 2000 Index (RUT)

3.0 Selected Industry Groups

3.1 Banking Index (BIX)
3.2 U.S. Home Construction Index (DJUSHB)
3.3 Transportation Index chart (TRAN)

4.0 Currencies

4.1 U.S. Dollar (DXY)

5.0 Commodities

5.1 Oil Fund and Index (USO and OIX)
5.2 Gold Fund (GLD)

6.0 Bonds

6.1 10-year Note, Yield (TNX)

7.0 Summary


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1.0 Overview

Today's Numbers

1.1 Markets at a Glance--Corrective Bounce

The bounce off the January lows has many declaring the bear-market decline is over. Say what? That would be the shortest bear market on record I think. Others are saying it was just a correction within the continuing bull market. I could buy that, but I don't. I watch for evidence in the bounces to see what the price patterns are telling me and not what the Cheerleading Network is telling me.

The bounce so far is corrective looking--lots of overlapping highs and lows and full of the types of moves that you see in corrections (it has not been impulsive to the upside). This has me looking for where the bounce might end, to short it, rather than looking for dips to buy. The dip buying will come but not until I hear wailing and gnashing of teeth that there is no bottom in sight and the VIX is north of 60.

As I'll review in the charts, prices remain in established down-channels from the October highs. The trend is your friend and we should therefore be looking for shorting opportunities in a downtrend rather than for bottoms. Most people hate trading in a bear market and therefore would rather look for buying opportunities. I would too but only for short term trades and only if you can watch the market during the day. If you're not comfortable trading the short side, or in a bear market, then cash (U.S. Treasuries) is the place to be right now.

The setup as of tonight is very similar to the setup we had towards the end of December, which was followed by some pretty strong selling into the low on January 23rd.

1.2 Hope-filled Rally

If hope were a commodity I'd buy fistfuls of it during a bear market. Bear market rallies are almost always based on hope. Hope that we've found a bottom, hope that what was causing fear in the market has gone away, for good (think banks and further write-down worries) or hope that those nasty bears will get annihilated by the next surprise Fed rate cut. It's called the slippery slope of hope because so many investors hang onto hope as they watch their investments get cut down with another selloff.

Eventually of course the hope turns into a real rally and those who held on start to feel relieved that they were correct all along. But I've got friends who are still holding and hoping that their tech stocks will return to the year-2000 level when they bought them. It's the reason most will hold onto their investments all the way down into the basement section of Value Village (where they'll be buying their next wardrobe, not that there's anything wrong with that). How many analysts rode the tech dot bomb into the toilet before issuing a sell signal?

The deer-in-the-headlights reaction (freezing when you know you should be stopping yourself out of a bad trade) is a hopeful reaction--"if I don't do anything I just know it will reverse and I'll be able to get out even." Hope is a killer in the stock market--the moment you start hoping is the moment you should be out of your position. If you have a very good reason (at least to you) for holding onto a losing position then it's not hope that's keeping you in the trade. Hopefully (pun intended) that reason is based on sound technical reasons (fundamental reasons if you're a Very long term trader) and not the fingers-crossed variety.

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So the market has seen a bounce from the January lows and of course there are many analysts who are saying the market correction is over and that we're ready to rally. These are the same people who hope there are no more nasty surprises that will cause more credit contraction, bond write-downs, etc. It would be great if their hope comes true but the risks out there, especially in credit land, are currently too large to warrant staying invested based on hope. We need to see concrete evidence that the credit crisis is being resolved and unfortunately we're seeing just the opposite.

There is mounting evidence, as I and others have been warning about for well over a year, that the subprime mess will not stay contained within the subprime world. Prime mortgages are starting to see a spike in loan defaults and foreclosures. Credit card loans, auto loans, commercial loans and you-name-it loans are all seeing the same thing--there's just too much debt (that was packaged and sold to investors globally) and not enough income to pay it down.

I've been saying that the credit implosion will happen mind-boggling fast (relatively speaking--perhaps unwinding in two years, or less, what it took 10 years to build) and it will take the stock market down with it--fear will become pervasive. As I'll review in the charts, the price pattern is perched on the edge of a cliff here and we could be one step away from some very significant and relentless selling that takes hold of the market.

1.3 Economic reports

Today's reports included retail sales and the pre-market reaction to the report is what gave us our gap up this morning. Too bad the rally was over in less than 5 minutes. As you can see, tomorrow's reports will not be market moving.

Retail Sales
People were prepared for a dismal report so when the report instead showed a surprising uptick in sales, the market rallied more out of relief than anything else. Or at least the shorts covered first thing in the morning but then it wasn't followed by any real buying to push it higher.

January retails sales improved +0.3% vs. expectations for -0.3%. Auto sales provided the boost whereas sales in other areas were generally flat. Housing related sales (furniture, electronics, and building materials) were not surprisingly down.

The chart of retail sales shows a down trend since the peak in 2005, chart courtesy briefing.com:

I drew a little uptrend from the low in 2006 and you can see it was recently broken. January's bump higher may be nothing more than a test of its broken trend line. And you thought trend lines only worked on stock prices.

Business Inventories
Inventories increased +0.6% (which helps GDP) while sales declined -0.5% and that made for an inventory-to-sales ratio of 1.26 which is slightly higher than the previous month. But as the following graph shows, the inventory-to-sales ratio has been steadily declining since 1990, chart courtesy briefing.com:

A low I/S sales ratio is very good for businesses as it makes them lean and mean and better able to absorb an economic slowdown. It's a good thing because one is coming.

Crude Inventories
U.S. crude supplies rose 1.1M barrels to 301.1M, about a third less than expected. Gasoline supplies were up by 1.7M barrels and distillate stocks fell by 100K barrels. Capacity utilization rose to 85.1% from 84.3% the previous week.

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2.0 Equities

2.1 S&P 500 Index (SPX)

SPX chart, Daily

SPX has bounced back up to the top of its parallel down-channel and is setup for a turn back down. The significant thing about the price pattern is that the selloff could make the December-January decline look small. The way the pattern is set up, the next decline is likely to drop out the bottom of the parallel down-channel. So that's the risk if you're holding on "hoping" the rally will continue.

Notice the fractal pattern between the November-December bounce and the January-February bounce. The move up from the January low to the lower high today looks like the move up from the November low to the lower high towards the end of December, both at the top of the parallel down-channel. Another 250-point drop in the SPX would take it down to about 1125 by mid March. But the wave pattern suggests the drop could be stronger and faster than that.

But there remains some upside potential, shown in pink, for the rally to make it up to the downtrend line from October. Based on the pattern of the bounce off last week's low I don't particularly like the chances for that to happen but we'll let price lead the way. As noted on the chart, it would be at least short term bullish if SPX can press above 1396. Use a break below 1317 as the signal that something a lot more bearish may be in play.

Key Levels for SPX:
- Short term bullish above 1396
- Longer term bullish above 1460
- Short term bearish below 1317
- Longer term bearish below 1270

SPX chart, 60-min

You can see that the bounce off last week's low is of the sideways/up variety with overlapping highs and lows. This is what gives the bounce a corrective look. Today the rally stopped right at the bottom of the parallel up-channel from the January low where it crossed the top of the parallel down-channel for price action since October. Use a break of the short term uptrend line from Monday's low as the signal that the bounce is probably finished.

SPX chart, Weekly

For a wider perspective of where we are and why I say the selling could become strong and relentless. It's not out of the realm of possibilities to see the 7-year rally off the October 2002 low get retraced in a year's time. Sound too bearish? Consider the risks we're hearing about the massive credit problems and the systemic problems that could cause a collapse in the house of cards we call the banking system.

I like to use EW (Elliott Wave) counts to help me judge where the stock market is and where it could be heading and right now I've got a wave pattern that suggests strong selling is about to take hold. The news about the financial woes only reinforces my belief that there's a good chance it will happen.

2.2 Dow Jones Industrial Average (DOW)

DOW chart, Daily

The DOW's daily chart looks a little messier but I'm trying to show where the rally could be headed if it doesn't turn back down here. First of all notice that stopped at the top of the down-channel like SPX did. I've drawn in a Fib projection at 13253 for two equal legs up from the January low. That projection crosses the downtrend line from October on February 25th. That's also where the top of a bull flag (small parallel up-channel from January) crosses and that kind of correlation always gets my attention.

So again, if the rally can keep going from here, the key level at 12767 needs to get taken out for at least the short term bullish pattern (pink) to play out. But a drop below 12100 would spell trouble for the bulls.

Key Levels for the DOW:
- Short term bullish above 12767
- Longer term bullish above 13300
- Short term bearish below 12100
- Longer term bearish below 11634

DOW chart, 60-min

Same pattern as the SPX--price is getting pinched between the short term uptrend line from Monday and the underside of the broken parallel up-channel from January. I've noted the gap close at 12631 (from the gap down on February 5th) so there is the possibility that we'll see the market make a stab to close it. That could also give us a little "throw-over" above what appears to be a rising wedge--any jump above it and then drop back down inside would be a sell signal.

SPX doesn't show the same gap but the closing price on February 4th was 1380.82 (ES, the S&P 500 emini futures, closed at 1379.25).

2.3 Nasdaq-100 Index (NDX)

Nasdaq-100 (NDX) chart, Daily

The techs have been on a slightly different price path than the blue chips. The rally ended in October at the end of the month instead of the middle and the bounce started earlier in November and finished near the same time as the others in December. This has resulted in a slightly wider parallel down-channel and the top of the channel has not been tagged yet like the DOW and SPX. Its price pattern also supports a little higher in its current bounce to give us a rally off the January low with two equal legs up (or a little more) near 1886 (1880 on the 60-min chart, explained below) or perhaps up to the 1920 area.

If the broader market starts to sell off hard then it will be difficult for the techs to hang on. Either that or the techs will rally and the blue chips will start down before the techs, like they did in October. There are several possibilities but the NDX chart looks better for a continuation higher.

Key Levels for NDX:
- bullish above 1920
- bearish below 1715

Nasdaq-100 (NDX) chart, 60-min

The 60-min chart shows a closer view of the bounce off the January low. It looks more like a big sideways consolidation. For some reason the highs and lows are a little different on the intraday chart than the daily chart and the price projection for two equal legs up on the 60-min chart is just shy of 1880 (it may have to do with the need to combine the old and new NDX symbols in QCharts to get the continuous price chart). I trust the 60-min chart more.

Note gap closure from the gap down on February 5th would be at 1828.88. If price rallies above that then I'd look for a possible top near 1880. I've drawn in the top and bottom of what could be a developing sideways triangle (with the 'D?' label at the next low). That's just a guess at this point and I'll update this regularly on the live Market Monitor.

2.4 Russell 2000 Index (RUT)

Russell-2000 (RUT) chart, Daily

The RUT looks more like the DOW and SPX and it too stopped today at the top of its parallel down-channel. It has exactly the same setup here as the blue chips.

Key Levels for RUT:
- Short term bullish above 731
- Longer term bullish above 770
- Short term bearish below 688
- Longer term bearish below 650

Russell-2000 (RUT) chart, 60-min

The RUT has been slithering up underneath the bottom of its parallel up-channel from the January low. It stopped just shy of the top of its parallel down-channel from the October high. A little higher and it will be able to close its February 5th gap at 723.14.

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3.0 Selected Industry Groups

3.1 Banking Index (BIX), Daily chart

While the broader market has attempted to bounce off this week's lows, the banks have been sitting here like a lump on a log. There are a lot of nervous investors in banks and I don't blame them. They're waiting for the other shoe to drop but nervously hoping (there's that word again) that if they buy the banks here they'll be able to participate in a big relief rally. I think it's too early to be thinking long and I would need to see the banks break their recent high near 297 before I got bullish. In the meantime I think we'll see the banking index take another trip down to the bottom of the parallel down-channel.

BTW, keep an eye on MACD here--if price can rally back up it will get MACD crossing back up at the zero line. Coming down to the zero line and then crossing back up would be a bullish buy signal for the banks.

3.2 U.S. Home Construction Index (DJUSHB), Daily chart

Like the banks, the home builder index has been marking time this week. The daily candles can barely be seen on this chart. I expect another leg down and still think a final low might be found around the 213-216 Fib projections.

3.3 Transportation Index chart (TRAN), Daily chart

I'm hoping we'll see a minor new high for the Transports because it make a good ending pattern for the rally from January. The price pattern for the Trannies has been very difficult to figure out but now it's starting to make some sense here. As shown, the next move should be a strong selloff. A move above 4900 (approximate) would suggest more bullish things, especially since it would be a recovery back above its 50, 100 and 200 moving averages. But the 200-dma has been a brick wall since it broke below it last August.

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4.0 Currencies

4.1 U.S. Dollar (DXY), Daily chart

I haven't seen any evidence yet that suggests the dollar is going to follow the green path higher. Instead the price pattern looks like it will remain in a sideways triangle pattern for at least another month before dropping out of it and making a final low. But a rally above the start of the triangle pattern, 77.85, would negate the pattern and suggest the bullish price path is the right one.

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5.0 Commodities

5.1 Oil Fund and Index (USO and OIX)

Oil Fund (USO), Daily chart

Keep an eye on the dollar for clues for the commodities. Right now the bearish price pattern for oil says the H&S neckline near 68.80 will break (near 85 for oil). Obviously that would be negated with a rally to a new high above 79.09.

Oil Index chart, Daily chart

As goes oil and stocks, so go the oil stocks. It's when they go in different direction that things can get a little confusing. Oil has a potential H&S shoulders topping pattern and stocks have a bearish pattern. Therefore I expect that once the current bounce is finished (either here at the 50% retracement of its January decline or a little higher around 830) we'll see the oil stocks head lower again. It takes a break above 850 (approximate) to say something more bullish is happening (again probably in synch with both an oil and stock market rally, neither of which I expect to see).

5.2 Gold Fund (GLD), Daily chart

Gold is threatening to break down after not being able to make a new high this month (which silver was able to do). That might have been a truncated finish for gold. But I'm watching to see if it can turn back up and head for the 95-96 area (there's a Fib projection for gold at 966, April contract). A break below the 85.77 low in January would say the rally is finished and I believe we'll in for a long downward correction in gold.

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6.0 Bonds

6.1 10-year Note, Yield (TNX), Daily chart

Bonds have been consolidating since the spike up off the January low (in yields). This looks constructive for another rally in yields and then it will be a matter of trying to figure out how high and how long. I think 4.0%-4.3% is the range before yields turn back down.

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7.0 Summary

This is opex week and anything goes. But we're now heading into the tail end of opex and usually most of the squaring of positions has been taken care of by now (with the hope that sold options will simply expire worthless). It's only when there's a big move through high-open-interest strike levels that we will sometimes see an acceleration of the move as hedging exacerbates the selling/buying. So stay aware of the possibility for a big move even though Thursday and Friday of opex have generally been quiet days in the market.

By price patterns and trend lines I see the market as vulnerable to a selloff so be careful if you're long the market. We could get an early rally on Thursday that fails--I'd certainly look at a rally failure as an opportunity to test the short side of the market since it could be a very lucrative play that lasts more than a few weeks. I hesitate to even mention a "position" trade since this market has not been kind to those who don't take profits quickly from a winning trade. Reversals of reversals of head fakes seems to be the norm.

Bear markets are hard to trade but when you see a rally to resistance, if you like playing the short side, you need to take the setup. Declines can be swift and difficult to get in (always worrying about it flying back up against you). That's why I prefer picking tops--I can test it against the high and get out quickly if it presses higher again. I nibble at it until it works (or not--3 times and I figure I'm too early).

Here's a summary of the key levels noted under each of the daily charts:

Key Levels for SPX:
- Short term bullish above 1396
- Longer term bullish above 1460
- Short term bearish below 1317
- Longer term bearish below 1270

Key Levels for the DOW:
- Short term bullish above 12767
- Longer term bullish above 13300
- Short term bearish below 12100
- Longer term bearish below 11634

Key Levels for NDX:
- bullish above 1920
- bearish below 1715

Key Levels for RUT:
- Short term bullish above 731
- Longer term bullish above 770
- Short term bearish below 688
- Longer term bearish below 650

Good luck and I'll see you next Wednesday. Join us on the Market Monitor for live updates in this difficult trading environment.
 


 

New Plays

Most Recent Plays

Click here to email James
New Plays
Long Plays
Short Plays
None CTAS
  HD

Play Editor's Note: HON, LCC, and OMX all look like potential bearish candidates. We're also watching SBUX for a breakdown under its 2008 low.


New Long Plays

None today.
 

New Short Plays

Cintas Corp. - CTAS - close: 30.00 chg: -1.08 stop: 31.15

Company Description:
Headquartered in Cincinnati, Ohio, Cintas Corporation provides highly specialized services to businesses of all types throughout North America. Cintas designs, manufactures and implements corporate identity uniform programs, and provides entrance mats, restroom supplies, promotional products, first aid and safety products, fire protection services and document management services to approximately 800,000 businesses. (source: company press release or website)

Why We Like It:
Shares of CTAS are floundering in a bearish trend of lower highs and lower lows. The stock just produced a failed rally near $31 and its 10-dma. Now shares are poised to breakdown under psychological support at $30.00. We are suggesting a trigger for shorts at $29.75. Our short-term target is the $27.00-26.00 range. The P&F chart is bearish with a $24 target. FYI: The most recent data puts short interest at 1.7% of the 131 million-share float. That is a short ratio of 1.5 (about 1.5 days worth of average volume to cover).

Picked on February xx at $xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 03/20/08 (unconfirmed)
Average Daily Volume: 1.5 million

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Home Depot - HD - close: 27.51 chg: -0.83 stop: 29.16

Company Description:
The Home Depot is the world's largest home improvement specialty retailer, with 2,238 retail stores in all 50 states, the District of Columbia, Puerto Rico, U.S. Virgin Islands, 10 Canadian provinces, Mexico and China. (source: company press release or website)

Why We Like It:
HD's big rally in January was a fake. More correctly it was nothing but a correction. The stock reversed at its 38.2% Fibonacci retracement of its prior down leg. The last couple of weeks have seen HD consolidating sideways under short-term resistance at its 10-dma. Meanwhile there have been two homebuilders come out and say that there is no end in sight for the housing slump. Aggressive traders could short HD here. We want to see a little more confirmation of the breakdown under the 50-dma. We're suggesting a trigger to open bearish positions at $27.24. If triggered our target is the $25.10-25.00 zone. You could aim for $24.00. The P&F chart is bearish and points to a $21 target. FYI: We don't have much time. There is less than two full weeks before HD reports earnings. We do not want to hold over the announcement. The most recent data puts short interest at 4.3% of the 1.67 billion-share float. That happens to be about 4 days worth of short interest.

Picked on February xx at $xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/26/08 (confirmed)
Average Daily Volume: 20.0 million
 

Play Updates

Updates On Latest Picks

Click here to email James

Long Play Updates

Acuity Brands - AYI - cls: 45.92 chg: -1.18 stop: 43.49

AYI hit some profit taking after rising to resistance. Shares lost 2.5% albeit on low volume. Look for a bounce near $45.00 as a potential entry point. Our target is the $49.50-50.00 zone. The Point & Figure chart looks very bullish with a $62 target and a breakout over resistance.

Picked on February 5 at $45.50 *triggered
Change since picked: + 0.42
Earnings Date 04/03/08 (unconfirmed)
Average Daily Volume: 857 thousand

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Expedia - EXPE - close: 24.99 chg: -0.14 stop; 23.39

EXPE held up pretty well. Shares only lost 0.5% versus the S&P's 1.3% decline. If you are looking for a new entry point then look for a dip near $24.50. More conservative traders might want to consider a tighter stop near $24.00. Our target will be the $27.00-27.50 zone.

Picked on February 11 at $24.25 *triggered
Change since picked: + 0.74
Earnings Date 02/07/08 (confirmed)
Average Daily Volume: 3.7 million

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General Moly - GMO - close: 9.98 change: -0.13 stop: 9.18

GMO is still trading sideways under short-term resistance near $10.25. We don't see any changes from our previous comments. We see potential resistance at $10.50 and its 50-dma so we are suggesting a trigger to buy GMO at $10.55. If triggered we have two targets. Our first target is the $12.40-12.50 zone near its December highs. Our second, more aggressive target is the $13.90-14.00 range. We are starting with an aggressive (wide) stop. You may want to adjust yours.

Picked on February xx at $xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 03/31/08 (unconfirmed)
Average Daily Volume: 665 thousand

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Microsoft - MSFT - close: 28.50 change: -0.46 stop: 27.39

MSFT's first test of technical resistance at its 10-dma failed. This is bearish and it looks like the stock is headed back for the $28.00 level. We would try and buy the dip in the 28.20-27.90 zone but in reality we would consider bullish positions anywhere in the $27.50-29.50 region. We have two targets. Our four to six week target is the $31.85-32.00 range. We are considering a longer-term target in the $34 region.

Picked on February 10 at $28.56
Change since picked: - 0.06
Earnings Date 04/24/08 (unconfirmed)
Average Daily Volume: 90.7 million

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Varian Semi. - VSEA - close: 35.04 change: -0.83 stop: 33.45

Today's market-wide sell-off took some wind out of VSEA's sails. If the market continues lower then look for a dip or a bounce near $34.00 as a new bullish entry point. Our target is the $39.75-40.00 range but we will need to watch for potential resistance at the exponential 200-dma and the simple 100-dma. The Point & Figure chart for VSEA has turned bullish and points to a $46 target.

Picked on February 13 at $35.75 *triggered
Change since picked: - 0.71
Earnings Date 04/24/08 (unconfirmed)
Average Daily Volume: 1.5 million
 

Short Play Updates

Terra Nitrogen - TNH - cls: 127.34 chg: +0.98 stop: 137.26

The stock doesn't see many of them but it was actually a quiet day for TNH. Like most of the fertilizer stocks it out performed the broader indices. However, the trend is still bearish. We do not see any changes from our previous comments. Currently we're suggesting readers cover their shorts (exit) at $117.50-115.00. Then we're suggesting readers buy the dip near its 200-dma in the $116.00-114.00 zone. We have two bullish targets on the bounce. One at $124 and then at $134. Once the bullish play begins our stop loss will be $109.45. Meanwhile the latest data puts short interest at 3% of the very (VERY) small float of 4.8 million share. A 3% short interest is not normally that worrisome but that is a very small float and raises the risk of a short squeeze.

Picked on February 07 at $129.40
Change since picked: - 2.06
Earnings Date 02/070/08 (confirmed)
Average Daily Volume = 455 thousand

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United Parcel Ser. - UPS - cls: 72.34 chg: -1.17 stop: 74.05

Another strong rally for crude oil sent the transports lower. UPS lost 1.59%. This looks like a new entry point for shorts but readers might want to wait for a breakdown under $72.00 first. Our target is the $66.00-65.00 zone.

Picked on February 10 at $70.58
Change since picked: + 1.76
Earnings Date 04/24/08 (unconfirmed)
Average Daily Volume: 5.4 million

---

Xerox Corp. - XRX - cls: 15.01 chg: -0.48 stop: 16.01

XRX gave back all of yesterday's gains with a 3% sell-off today. The stock was flirting with another breakdown under $15.00 (and $14.90) late this afternoon. We've been suggesting that a new low under $14.90 could be used as an entry point for shorts. Our short-term target is the $13.55 mark. XRX's Point & Figure chart is bearish with a $10.50 target. The most recent data listed short interest at just 0.6% of the float.

Picked on February 07 at $14.95 *triggered
Change since picked: + 0.06
Earnings Date 01/24/08 (confirmed)
Average Daily Volume: 5.9 million
 

Closed Long Plays

None
 

Closed Short Plays

None
 

Today's Newsletter Notes: Market Wrap by Linda Piazza and all other plays and content by the Option Investor staff.

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