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Semiconductors, Channels, And Divergences

12/17/04 02:18:13 PM
by David Penn

As the semiconductor HOLDRS snake their way through a trend channel, a December positive stochastic divergence suggests higher prices ahead.

Security:   SMH
Position:   N/A

It's not a pretty bull market in the semiconductor group. But to riff off of a phrase from US defense secretary Donald Rumsfeld, you enter the markets on the side of the bull market you have, not the bull market you want or wish you had. That said, semiconductors have consistently made higher highs and higher lows since putting in a bottom in early September. In fact, the trend channel shown in Figure 1 has bound their ascent fairly consistently.

The semiconductors (as measured by the HOLDRS, SMH) had been in a bear market for much of 2004, after falling from a January peak near 46. Like the present bull market in semiconductor stocks, the previous bear market was also long contained within a trend channel. In fact, it was the downside break of the trend channel in August 2004 that signaled an unsustainable acceleration in SMH's decline. The August low, then, formed the first trough in what became the positive stochastic divergence that led to the market bottom in September and the subsequent autumn rally.

Figure 1: Semiconductor HOLDRS. A midmonth pivot low on overwhelming volume in mid-December may prevent the price of the semiconductor HOLDRS from pulling back to the lower boundary of this three-month trend channel.
Graphic provided by: Prophet Financial, Inc.
Don't be surprised if the positive stochastic divergence from the August to September lows didn't show up on your chart. I saw the divergence as a draw on my 7,10 stochastic, but my eSignal 7,10 stochastic was unequivocal in showing that consecutively higher troughs in the stochastic matched the consecutively lower price troughs in August and September.

In any event, the semiconductors have snaked upward between the parallel lines of the trend channel, and tightly along their 10-day exponential moving average (EMA) as well. And so far, each month has brought a higher low and a higher high. What is especially interesting at present is the fact that SMH has made its higher low here in December, and if the pattern since September is to continue, SMH should make a higher high before the end of the month. In addition, this higher lows comes some distance from the lower boundary of the trend channel. This, in and of itself, suggests the possibility that SMH's move up might accelerate--perhaps in the same way that the Standard & Poor's 500's trend accelerated in early November (see my "Testing The Channel," Advantage, December 10, 2004). Such an acceleration would entail a move up to the upper boundary of the trend channel, a breakout above the channel's upper boundary, and then a pullback that would find support on the upper boundary of the channel in a classic, resistance-turned-support maneuver.

That gets us a little ahead of the game. But part of the reason I think such a move might be imminent has to do with the positive divergence that has developed between the consecutively lower late November and mid-December price lows on the one hand, and the consecutively higher late November and mid-December stochastic price troughs. While not as large as the divergence in August/September that strongly suggested higher prices, the current positive divergence is the best evidence that the SMH has the technical capacity to test the upper boundary of the channel.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine,, and Advantage.

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Comments or Questions? Article Usefulness
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Date: 12/17/04Rank: 5Comment: 
Date: 12/18/04Rank: 5Comment: Excellent article, but do I misunderstand the consecutively lower stochastic troughs in November and December as confirming the December price as lower than the November price low?
Date: 12/18/04Rank: 5Comment: Excellent article, but do I misunderstand the consecutively lower stochastic troughs in November and December as confirming the December price as lower than the November price low? Oh, I am looking at MACD and not SS... please excuse me.
Date: 12/18/04Rank: 5Comment: 

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