Microsoft Giveth...And Taketh Away

Well folks, in an after-hours bomb this evening, when Microsoft announced earnings that "beat the street by a penny," (where have I heard this before?) they stunned the world by taking back their "sales and revenue are better than we anticipated" statement from one week ago and replacing it with an earnings warning for future quarters. Oops! They mentioned a little something about continued softening demand for personal computers along with a $2.6 billion charge for investment losses. Unless the software market underwent massive changes in just one week, this basically amounts to a lie from Microsoft and I can't imagine investors taking too kindly to this news. Interestingly enough, we were mentioning in our office this week that the chart of Microsoft was looking kind of strange for a stock that was giving out so much great news over the past couple weeks. The chart suggests that people "in the know" may have already been aware of this negative development.

Looking at a daily chart of Microsoft, we can see clear signs of distribution of the stock during the frenzy of "positive" news announcements over the past few weeks. This is just one of many indicators we use that gave us clear signals of stock distribution. We also noted today that, despite all this "positive" news, Microsoft was still unable to break above the crucial 72-73 resistance that has been holding it in check for over a month. Were we short for this? Unfortunately, no. We didn't act on our suspicions. I am showing this chart as an example of what to look for in the future in highly hyped stocks (or, conversely, highly bashed stocks). Often, the risk associated with taking a position in a stock into earnings far outweighs the potential reward. In this case, had we established a short position based on our chart patterns/indicators, we would have been paid handsomely.

Moving on to the Dow Industrials, an exciting pattern played out today almost perfectly. As you can see in the chart below, the Dow rallied almost exactly into a downtrending resistance line, before failing and closing below the key 10,600-level. The market made two attempts to take out this key resistance in early trading. By identifying this resistance level in this triangle formation, astute traders were able to establish short positions just when it felt like the market was going to rocket into the stratosphere. On the downside now, the Dow will need to hold support at the bottom end of this triangle formation (around the 10,250 level). Otherwise we will test the recent lows from July 11 and potentially fall below the 10,000 level. Given the fact that most of the major companies have announced earnings, there is not much left to help the Dow push upwards through the very difficult 10,600 resistance.



Over in the Nasdaq Composite, we see a similar pattern developing. Price action is squeezing into a key decision point for a break to the upside or downside. The markets slammed into resistance today at the downtrending resistance line, shown on the chart below. Unless the futures move substantially off their lows of Thursday evening, it is highly probably the Nasdaq will open below the psychologically important 2000 level. This will also put us below the support shown in the triangle formation drawn on the chart and sets us up for a potentially strong move downward. There are three gaps that have yet to be tested from just after our April 4 lows. Will the Microsoft news be the impetus for the test of these lower levels?



I've also included a chart of the S&P Retailing Index (RLX) and a potential play that could arise from any weakness in the RLX. Comments are shown on each chart.

The Microsoft news, as well as bad news from (PMCS), (SUNW), (GTW), will likely weigh heavily on the markets Friday. Unless something virtually miraculous occurs prior to the open, we will be seeing a pretty major gap down. It will be interesting to see what happens after the open. Will we get our "buy-the-dip" from the "it-can't-get-any-worse" crowd, or will we get a buyers' strike as people tire of trying to catch the elusive bottom? Will the majority of players walk away to start a summer weekend early, putting this volatile week behind them? We've got serious patterns playing out here and Friday's action will be key to the future health of the markets.

Best of luck trading -- have a great weekend!

Carolyn