Conexant Systems' Head and Shoulders Top

01/10/02 11:55:03 AM

by David Penn

While the Semiconductor index starts to round over, shares of Conexant Systems start to head south.

Security: CNXT
Position: N/A

One of the more valuable trading axioms I've come across may well be the dictum: Buy the strong and short the weak. In other words, if you are looking to go long equities, the best approach is to buy shares in the best companies you can afford. Assuming that your decision to go long is based at least in part by underlying bullish market action, the theory of buying the strong further assumes that in a generally bullish environment, the best companies will outperform not only the mediocre and bad companies, but also will possibly outperform the market itself. The virtues of equity diversification notwithstanding, while the Nasdaq 100 returned a little over 100% in 1999, Cisco returned in excess of 125%.

With the rally in the Nasdaq 100 stalled and the December highs beginning to represent topside resistance, I looked to some of the weaker stocks in the Nasdaq 100 (the QQQ components) to see if the stagnant rally in the broader index has shown up as significant weakness among the lesser stocks. What was interesting was that although some of the stronger stocks are mirroring the Nasdaq 100's inconclusive trading range, weaker stocks, such as Conexant Systems, were indeed already showing ominous signs of giving way.

Conexant Semiconductor's weakness may anticipate further near-term weakness in the broader semicoductor industry.

Graphic provided by: MetaStock.

Conexant Systems (CNXT) is a semiconductor stock. The included chart includes both the Philadelphia Semiconductor stock index (SOX) as well as concurrent price action in one of the larger semiconductor companies, Taiwan Semiconductor (TSM). Note how both TSM and the semiconductor index are moving almost completely in tandem. Both feature upwardly sloping trendlines that are unbroken as of this writing. In mid-December, both the TSM and the SOX rallied from contact with these trendlines and currently look as if these rallies are, at a minimum, leveling off. Additionally, both Taiwan Semiconductor and the Philadelphia Semiconductor stock index look to be retreating from tests of the December highs, making a regress to the trendline-- and short-term price weakness-- increasingly likely.

However, the situation with Conexant Systems appears more precarious. The same upward trendline that guided the semiconductors to their present highs was broken by CNXT in mid-December. But where Taiwan Semiconductor and the SOX rallied from the mid-December decline, CNXT continued to decline, finally finding support at the previous correction low in mid-November. CNXT did eventually rally in the second half of December. Unfortunately, CNXT's test of its December high quickly proved to be unsuccessful (recall that, of this writing, the jury was still out on the tests for Taiwan Semiconductor and the SOX), and CNXT again retreated to a previous correction low.

This price action has CNXT in a head and shoulders top, with a peak of about 18 and an upwardly sloping neckline at about 13. A chart pattern of these dimensions would suggest a downside move beneath the neckline of about 5 points, making for a downside target of 8. There is significant amount of support in this area, with minor correction lows at 10 and 9.5 before the October (pre-rally) low of 6.5. A decline of those proportions may not be likely, particularly if the stronger semiconductor stocks and the index itself rally from the trendline, toward which they seem to be headed. Nevertheless, a minor correction in a continuing rally for the strong stocks, may still allow for opportunities on the short side for the weak.

David Penn

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

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HEAD & SHOULDERS

Conexant Systems' Head and Shoulders Top

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