The PHLX Semiconductor Index (SOX) may have entered the final stage of a three-month consolidation pattern that will yield the next rally leg in the multi-year uptrend. That buying impulse has major historical significance because the instrument is trading just 150 points below the 2000 dotcom parabolic peak, with that level set to generate heavy resistance that could signal a long-term top.

It took the Powershares QQQ Trust (QQQ) and the Nasdaq-100 Index nearly 18 months to clear similar resistance once it was reached in July 2015, highlighting the chip sector's major challenge at a time that Wall Street analysts are speculating about how much longer this already long-in-the-tooth bull market will last. In any case, plenty of running room up to that level should support breakout strategies as long as traders utilize conservative risk management techniques. (See also: The Industry Handbook: The Semiconductor Industry.)

The PHLX Semiconductor Index topped out at 1,362 in March 2000 following a parabolic uptrend and crashed into the fourth quarter of 2002, losing nearly 85% of its value. A bounce into mid-decade stalled below the .386 Fibonacci sell-off retracement level, ahead of renewed selling pressure that undercut the 2002 low in 2008. It bottomed out at 167.88 in November and turned higher in 2009, spending the past eight years retracing the eight-year downtrend.

The uptick stalled at the .786 retracement level in June 2017, giving way to a triangular consolidation pattern that found support near 1,000 in July. The index has been working its way back to the rally high for the past two months, building interim resistance at 1,120 that could issue an early buying signal ahead of a breakout that could go vertical into multi-decade resistance.

Market timers can play the broad chip sector through the VanEck Vectors Semiconductors ETF (SMH) or the iShares PHLX SOX Semiconductor Sector Index Fund (SOXX). Direct purchases of the sector's strongest leadership could offer higher reward with greater risk because that group includes NVIDIA Corporation (NVDA), the top chip performer in the past two years. (For more, see: Top 5 Semiconductor ETFs.)

Microchip Technology Incorporated (MCHP) stock broke out above 2007 resistance in the lower $40s in 2013, but upside momentum failed to develop until July 2016, when it took off in a strong trend advance. Price action eased quickly into a rising channel, peaking at $87.49 in June 2017 and dropping into a rounded correction that bounced at channel support and the 50-day exponential moving average (EMA) in July.

A steady uptick reached June resistance last week, yielding a pullback and bounce that has now completed a small-scale cup and handle pattern. A breakout could reach channel resistance now centered near $100, with that level generating strong headwinds that demand a timely exit. The rally might correspond with a run-up of SOX into the 2000 high, which would set off sell signals across the semiconductor universe. (See also: Microchip Q1 Earnings Top Estimates, Revenues Up Y/Y.)

Broadcom Limited (AVGO) shares exited a two-year consolidation pattern in 2013 and took off in a strong uptrend that topped out near $150 in June 2015. The stock pulled back into August and rallied to a new high in March 2016, but the breakout failed to attract significant buying interest, yielding a shallow uptick into January 2017. It then entered a more vertical advance that continued into the June high at $257.

Two marginally higher highs since that time have failed to confirm a healthy breakout, but limited downside has held the string of higher lows, raising the odds for a buying surge that attracts the missing sponsorship. At this point, $260 looks like the trigger price for a strong rally impulse that could reach $300. (See also: NVIDIA, Intel, Broadcom Are All Cloud Buys: RBC.)

The Bottom Line

The PHLX Semiconductor Index is testing June's bull market high and could break out, but the next rally wave will run into a buzzsaw of resistance at the 2000 parabolic top. (For additional reading, check out: How Broadcom Will Beat NVIDIA.)

<Disclosure: The author held no positions in the aforementioned securities at the time of publication.>

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