The PHLX Semiconductor Index (SOX) rallied within 20 points of the 2000 net bubble high on Nov. 24 and turned sharply lower, cutting through the 50-day exponential moving average (EMA) at 1,250 and hitting a seven-week low. The decline still has not reached deeper support between 1,160 and 1,180 generated by a rising trendline going back to February 2016, while that price zone also marks the interface between the .382 and .50 retracements of the rally off the early summer low.

This price structure predicts that we are getting close to a strong bounce that tests the upper regions of the powerful advance, but the sector remains vulnerable to a final downdraft that shakes out another batch of complacent shareholders. Micron Technology, Inc. (MU) earnings after Tuesday's closing bell could decide the group's short-term fate, perhaps generating a buy-the-dip opportunity that fails at a lower high ahead of even weaker 2018 price action.

The semiconductor sector is likely to underperform next year regardless of broad market direction, with 17-year resistance maintaining pressure on the group. That is an issue for investors and long-term market timers, but two-sided price action should keep position and swing traders busy and profitable, buying support and selling resistance on their favorite chip stocks or highly liquid sector funds. (See also: SOX Semiconductor Index at 17-Year Resistance.)

 

The Vaneck Vectors Semiconductor ETF (SMH) came public in May 2000, just two months after the SOX topped out, lifting quickly to $105.75 and reversing in a bear market decline. The rally into November 2017 stalled eight cents above that peak, giving way to a pullback that has now settled just below the 50-day EMA and round number resistance at $100. Unusually strong selling pressure has dropped on-balance volume (OBV) to the lowest low since early October, when the fund was trading in the low $90s.

The ETF bounced off the .382 retracement of the July into November rally wave on Dec. 6 and held above that level last week. Testing at the 50-day EMA has now entered its 12th day, while weekly stochastics is approaching the oversold zone. While this bodes well for an eventual bounce as high as $103, price action so far has failed to generate buying signals, telling market players to stand aside into Micron earnings because the report is likely to end this impasse. (For more, see: The Industry Handbook: The Semiconductor Industry.)

 

Micron Technology stock completed a round trip into the December 2014 high at $36.59 in December 2017 and broke out immediately, lifting to a 17-year high at $48.89 on Nov. 27. It then joined other chip stocks in an intermediate decline, reaching the 50-day EMA at month's end. It has spent the first half of December crisscrossing that level in a holding pattern that should yield a trend wave, higher or lower, following this week's earnings report.

The rally reversed at the 50% retracement of the nine-year downtrend off the 2000 bubble high, marking a significant barrier that will take time to overcome. The stock is also overbought following a breakout impulse that started in the mid-$20s in August, with the 2014 peak cutting through the midpoint of the rally wave. This suggests that the stock could spend months building a trading range between the mid-$30s and $40s before resuming its upward trajectory.

Limited upside argues for aggressive risk management with both long and short trade entries. The sector posted its most prolific returns since the turn of the millennium in 2016 and 2017, making it unlikely that this torrid pace will continue in coming months. Broad price structure since early 2016 has also carved a long-term Elliott five-wave advance that may signal the uptrend's end ahead of a deeper correction and a new downtrend. (See also: Micron's Sell-Off Presents an Opportunity: MKM.)

The Bottom Line

Chip stocks have pulled back from major resistance in the past three weeks and could bounce strongly, offering opportune profits for well-timed position trades. The longer-term outlook is less bullish, with major sector funds and indices now stalled at multi-decade resistance. (For additional reading, check out: 4 Best Tech Stocks to Own in 2018: Fortune.)

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

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