Looking to the Semiconductors to Lead the Way-Phases versus Channels Part II

September 17, 2010

Mish's Daily Articles

By Mish Schneider

Earlier this summer, I wrote an article about high and wide channels using SMH - the ETF for Semiconductors - as a textbook example.

In a high and wide channel - if the price breaks out from either the up or downside of the parallel lines and then proceeds to trade back into the channel - a trap is often set for the bulls or the bears. In the case of a bearish channel, if SMH breaks below the low of the channel lines and comes back into it, that would be considered extremely bullish.

SMH Chart

On August 30, 2010, SMH had the first close underneath the channel. The next day, it looked like a confirmation. But, as the research shows:

The wider the channel, the less velocity the break up or down is. Tight and narrow channels generally have more follow through. The more the energy is consolidated, the more forceful the breakout or breakdown is.

On September 1st, SMH came back through the channel bottom closing higher from the day prior. Typically, one should wait for a second day confirmation. On September 2nd, SMH opened higher and gave a buy signal over prior day's high with a risk to either a close under the channel bottom for a miniswing position, or for a longer term position, the option of using a stop under the recent low of 24.14. As SMH has an Average True Range of $.64, using a $1.15 risk for a longer term position (assuming a long entry around 25.30) is certainly in line with a disciplined risk/reward parameter.

The Phase is Still Bearish

ETF Monitor

Above is a snapshot of our ETF Monitor which tells you the phase each of the ETFs are in. Notice that SMH is the only Sector ETF still in a bearish phase. What does this mean? First, that Semiconductors were hit hard when the market came off this summer. Second, that the other Sectors are either in Recovery or Accumulation Phases, but until we see a Recovery Phase established in SMH, the entire September rally is suspect. However, the channel reversal long established on September 2nd is still in play. There are three possible scenarios to look out for:

  • As SMH returns to the middle of the channel, especially as it nears the 50 day moving average which at time of writing this is at 26.70, it could stall and go back down to the bottom, with the distinct possibility of making a new low.
  • SMH trades above the 50 day moving average, closes there for 2 consecutive days and changes phases to Recovery.
  • SMH does indeed turn phases to Recovery, but stalls out at the 200 day moving average (now at 27.25), thereby fizzling before it gains the momentum to change to an Accumulation Phase.

An important consideration continues to be the lineup of the moving averages. Note that until the 50 crosses back over the 200 day moving average, the phase cannot turn GREEN or bullish. When trading a channel reversal - like any other trade you enter - determine your timeframe and risk. Then, regardless of whether or not SMH stalls midway through, fails, or takes out the high of the channel, you are clear about what you are willing to risk and where you should take profits along the way.

Happy Trading!

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