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November 3, 2009  Tue 12:17 PM CT

SMH: SEE CHART GET CHAIN FIND STRATEGIES

Back in February the semiconductors sector was a good indicator of  an impending trend change at a time when an uptick in the tape seemed nearly impossible to hope for.

The Semiconductor HOLDRS (SMH) exchange-traded fund turned up well before the rest of the market, defying expectations that a rally in chip companies was possible. The move also helped lead the rest of technology shares and eventually the broader market. 

Seven months later, the semiconductors have broken down technically. This morning's downgrade of the sector by Morgan Stanley has helped push a technical break of the index. It is worth spending some time on the two big technical bearish features, illustrated on the chart below, so that we can asses the future risk presented.

SMH Chart

First, the 10-day moving average (in pink) and the 50-day moving average (yellow) have crossed bearishly. That is, the shorter moving average, the 10-day, has dropped below the longer moving average, the 50-day. In many technical trading systems, this is a confirmed "sell" signal. The 10-day moving average line is now acting as a downtrend resistance line, rather than as a support. It forms the top of a bearish downtrend channel that began forming back in mid-October.

Second, there is a reversed bearish "descending triangle" pattern on the chart, shown in red. While not a conventional pattern, it nonetheless appears to have measuring implications down to the $21 area, shown by the light blue line.

As we can see by looking to the left, if the pattern is complete, it would take us all the way back to levels seen just before the last earnings season in July. As it happens, this would be roughly a 50 percent retracement of the gains made since March to the peak in October. Such moves are not to be unexpected in major corrections.

The key level to watch on the resistance side is at the $24 area, which is the bottom of the triangle formation. A move back above $24 would neutralize the pattern.

It would not, however, change the moving average signal. A sustained multiweek rally would be needed to do that.

(Chart data provided by Thomson Reuters)

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