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STOCHASTICS


Semiconductors Lead Nasdaq Bounce

12/23/03 11:08:37 AM
by David Penn

The November double top caught the attention of bears. But bulls liked the positive stochastic divergence and rising MACD histogram.

Security:   SMH
Position:   N/A

As the Dow Industrials soared to new highs in December, bears who weren't focused on the recalcitrant, nonconfirmation confirmation of the Dow Transports were likely licking their chops over the weakness of the Nasdaq. Even as of this writing, the Nasdaq has failed in December to close convincingly above its November highs. With stock leadership apparently shifting from the smaller caps of the Nasdaq and toward the blue chips of the Dow Industrials and S&P 500, those who have been expecting the markets to top out since, well, late May, have believed that vindication of their bearish views was right around the corner.

Not so fast. The recalcitrant, nonconfirmation confirmation of the Dow Transports (see my Traders.com Advantage pieces, "Transport Trouble," posted December 18th and, earlier, "Dow 3,000," posted December 4th) has turned into a bonafide confirmation. The Transports finally closed above 3,000 on December 22nd. This new high (vis-a-vis the November high) means that the Transports have now convincingly confirmed the new highs in the Dow Industrials. Combined with what appears to be an ascending triangle in the Transports, there is a growing possibility that the components of the Dow Transports will play catch-up for the next few weeks.

Figure 1: The Nasdaq continues to struggle to reach its early December highs.
Graphic provided by: eSignal.
 
Further reason for bullishness comes in the behavior of the semiconductor group, as revealed by the semiconductor HOLDR, SMH. Market observers and technical analysts have pointed to the double top in the semiconductor group, and have suggested that a sharp correction for this overvalued sector was likely. A quick review of the double top, however, suggests that any correction that would follow from a successful pattern might be limited, rather than sharp. Applying Weinstein's swing rule, the downside from the double top in SMH could have been expected to reach at least 37. However the market showed a remarkable inability to fall below 39 -- even after a sharp reversal day that negated a post-breakdown pullback (that reversal was the Monday morning, "So what if they caught Saddam?" sell-off).


Figure 2: Note also the rising MACD histogram, which suggests growing strength from the bulls.

Interestingly, the Tuesday following that sell-off appeared to be the end of the decline, as a long lower shadow (per candlestick analysis) suggested that the bears had run out of steam on Monday. As the market moved cautiously back up, a positive divergence developed between the two lows in December and the two December lows in the 7,10 stochastic oscillator. Specifically, while the SMH made lower lows, the oscillator was registering higher lows. This positive divergence was a powerful indication that lower prices for the SMH might be hard to come by in the near-term.



David Penn

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

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