Ambush Leaders, Don’t Chase Them
Semiconductors advanced again Friday
after two Merrill Lynch analysts issued bullish comments for makers of chips and
chip-making equipment. One problem: Semis have been in rally mode all week long.
Many of these stocks now look extended on a short term basis.
This is an area of obvious strength in
the market, but let’s not get caught chasing extended stocks. Some of the
semiconductor names are overdue for a pullback. Buy on pullbacks or on breakouts
from sound bases. That discipline will reduce (though never eliminate)
the risk of getting stopped out of new buys. Ambush the leaders. Don’t chase them.
I’ve plotted a 14-session Relative
Strength Index for some of the leading semiconductor stocks. The RSI, which has
no relation to relative strength, is a momentum oscillator that measures an
index or security’s performance against itself. It measures day-to-day up and
down closes in an index or security over a given period. Many of the
leaders of the latest rally are registering overbought levels on on the RSI,
with values of 70 or higher representing the overbought zone.
A word of caution: I don’t use RSI to
time my buys in individual stocks. But the indicator does serve to illustrate
extended conditions in some of these issues.
Take Analog Devices
(
ADI |
Quote |
Chart |
News |
PowerRating), which
on Wednesday broke out of a double-bottom
base on terrific volume. The stock has surged 71% from the second
bottom of the pattern, formed on Aug. 3. Analog Devices’ RSI now reads 70.
Stocks on a tear can stay in
overbought territory for some time. So I would never rule out a potential buy
purely on grounds of a high RSI. However, this reading does tell you that the
stock is at increased risk of a pullback at this point in time. As a pattern trader, I would let
Analog digest its recent gains, perhaps form a handle and create a pivot point,
before considering the stock for a future long trade.
Since Wednesday’s breakout, Analog
Devices has behaved reasonably well, pulling back Thursday on a volume
contraction. However, note that while the stock moved up 3 1/8 to 85 5/8 on
Friday, the advance came on still lower volume. Near term, institutional
enthusiasm for Analog has waned. Ideally, the stock would pull back on low
volume here and put in a handle
before moving higher on strong volume.
Chartered Semiconductor Manufacturing
(
CHRT |
Quote |
Chart |
News |
PowerRating) gained 2 3/4 to 86 5/8 on double average volume. Its RSI is closing
on the 70 level and has exceeded the 58 reading that coincided with its mid-July
top. Again, I don’t look strength in the mouth, but I don’t chase extended, high
RSI stocks either. Let this stock digest its gains and create a pivot point
while you watch for a possible entry point.
A few of the more obvious semiconductors ran into profit-taking as they neared technically overbought levels Friday — Intel
(
INTC |
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News |
PowerRating), for example. The stock retreated from its intraday high of 72 15/16
to close at 70 19/16, up fractionally but near the bottom of the day’s range.
You also can see Merrill Lynch’s
Semiconductor HOLDR
(
SMH |
Quote |
Chart |
News |
PowerRating) nearing overbought levels on the RSI after
recording its sixth straight advance. For more information on HOLDRs, check out
my introductions to exchange-traded
funds and HOLDRs.
On a related note, RSI has a variety
of uses, including spotting market bottoms. If this topic interests you, check
out my related tutorial.