Strength In Semiconductors?

05/04/05 02:19:55 PM

by David Penn

A 2B test of bottom and a positive stochastic divergence suggest near-term upside in the $SOX.

Security: $SOX
Position: N/A

They don't call it the "slope of hope" for nothing!

I was reading somewhere recently that you know that you're in a bear market when everybody is losing money and nobody seems to care. Maybe that defines the nervous action in technology stocks--especially semiconductors--in 2005. After all, if the broader market is truly in trouble, then technology and semiconductor stocks are likely to suffer a disproportionate amount of the pain. Chalk one up for avoiding such stocks like the plague.

On the other hand, semiconductor stocks in particular topped out in January 2004--meaning they've already been in a bear market for more than a year. Falling from above the 550 level back in early 2004, the $SOX fell below 350 in the late summer/early autumn of 2004 when positive divergences there helped anticipate the broad-based rally that sent the market higher throughout the balance of 2004 into the earliest days of 2005.

This only underscores the notion that if the market is poised to establish a bottom, even a temporary, tradable bounce, semiconductors would tend to be one of the best places to be. Chalk one up for buying semiconductor stocks at "sale" prices.

Figure 1: PHLX. This weekly chart of the Philadelphia semiconductor index shows both the positive divergences between the January and April lows (also apparent on daily charts of the $SOX), as well as the 2B test of bottom.

Graphic provided by: Prophet Financial, Inc.

So where does this leave prospective semiconductor speculators? It is true enough that the $SOX appears to be developing a positive stochastic divergence between the lower lows in January and April in price, and the higher lows in the corresponding 7,10 stochastic.

However, if the $SOX were truly forming a bottom of some permanence, then it would have been preferable for the August bottom to have developed the positive divergence. Arriving when and where it does, the January/April divergence does build a case for a near-term bounce in semiconductor stocks. But that case is not as compelling as it would have been had the divergence occurred at the more pronounced bottom in the summer of 2004. (Interestingly, there was no positive divergence at the August 2004 lows on the daily chart of $SOX, either.)

But focusing on the near term, it appears as if there is--at a minimum--a reason for semiconductor bears to feel less giddy and more cautious. Again, looking at the weekly chart (Figure 1), the $SOX established a lower low during the week of April 29 (lower relative to the previous weekly low during the week of April 15). But that lower low on April 29 has yet to show follow-through to the downside. Except for that intraweek penetration to cause the lower low, the 380 level has remained supportive.

These are the signs of a potential 2B test of bottom, which would require a reversal back above the level of the previous low (to be more accurate, above the high of the previous low bar) in order to be confirmed. In this case--basis the weekly chart--confirmation would require a move in the $SOX over 406-407.

The daily charts offer a lower confirmation point, even as they feature the same positive divergence and 2B test of bottom setup. In the daily chart of the $SOX, a move above 396 would put the 2B test of bottom in good stead.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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