Semiconductor Index Breaks Down

02/23/10 12:41:32 PM

by Chaitali Mohile

The Semiconductor Index was undergoing a steady bullish rally until an unanticipated breakdown appeared. Will the index resume its bullish path or will it drop further?

Security: $$SOX
Position: Sell

A robust rally was initiated in the Semiconductor Index-Philadelphia ($SOX) in early 2009 (Figure 1). Prior to the rally was a sharp downtrend during which time the average directional movement index (ADX) (14) descended from the 50 level, reducing the bearish hold on the trend, and offered an opportunity for the buyers. $SOX surged to 231.25 from the new low at 167.55, and later retraced to 188 levels, forming a higher low. The upward rally from 188 levels slipped above the previous high at 231 and converted the 50-day moving average (MA) resistance to support. By joining these two higher levels, you can draw an ascending trendline and a parallel lower trendline, connecting the higher lows from 188 levels. Thus, an ascending channel is visible in Figure 1.

Trading within the channel is a good and safe strategy in any kind of market situation. Since you can anticipate the breakout and breakdown points of the channel, you can place appropriate stop-losses for your trades. The channel breaks upward if the upper trendline is breached and opens fresh buying opportunities. This buy setup could be escorted by a stop-loss that is marginally below the upper trendline, as the price may retrace back to test the newly formed trendline support. On the other hand, if price cracks the lower trendline support, it could be considered to be bearish, suggesting severe damage to the stock/index. So it may be wise to set your stop-loss a few points above the lower trendline. Since the ascending channel is a bullish pattern, the downward breakout damages bullish sentiments. To determine the breakout points, you need to stay watchful of price movements.

FIGURE 1: $SOX, WEEKLY. The ascending channel has been breached downward. The index has bounced with the 50-day MA support to challenge the new resistance line.

Graphic provided by: StockCharts.com.

In Figure 1, you can see that $SOX moved closer to the upper trendline. This indicated that the index was ready to breach upward. However, the ADX (14) failed to develop in the bull's favor. The buying pressure was sluggish and the ADX (14) remained range-bound between 20 and 30 levels. The full stochastic (14,3,3) in Figure 1 frequently changed its direction in the bullish region of 80 and 50 levels. Due to lack of bullish strength in the rally, $SOX could not break upward; instead, the index retraced toward the lower trendline support. A minor bearish rally from the upper to lower trendline generated a short-term selling opportunity for the sellers. But $SOX bounced immediately without actually hitting the lower trendline. As the technical indicators did not improve, the rally again moved parallel to the upper trendline but failed to undergo the bullish breakout. Thus, the index continued moving within the upper and lower trendlines.

Although $SOX rallied 220 points from the low, the uptrend moved in the developing uptrend region, and the stochastic oscillator remained highly volatile. Due to these weak bullish notes, the index breached the lower trendline, suggesting major breakdown. Fortunately, the 40-day MA offered robust support to the bearish rally and prevented an additional fall. With the support of the MA, $SOX surged to challenge the lower trendline resistance. Such price movement is a common behavior of any stock/index. In this case, the price movement reveals the reason for positioning the stop-loss marginally above the lower trendline during the breakdown. Currently, $SOX is struggling to hit the new resistance line. The ADX (14) has turned weaker by moving below 20 levels and the stochastic oscillator is ready to move into the bullish area above 50 levels. Due to this mixed scenario, $SOX would be little reluctant to surge in the ascending channel. In addition, the current volatility and turbulence in the financial market across the globe would pour the bearish pressure in $SOX.

Thus, traders should be on their toes to trigger a short position whenever $SOX drops down from the trendline resistance.

Chaitali Mohile

Active trader in the Indian stock markets since 2003 and a full-time writer. Trading is largely based upon technical analysis.

Company:	Independent
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E-mail address:	chaitalimohile@yahoo.co.in
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Semiconductor Index Breaks Down

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