Despite a mid-week attempt to rally, the US Equity markets ended-up succumbing to more downward pressures later in the week. While the DOW and S&P500 are marginally up this week in comparison to the prior week's settlements, some incredible weakness in the tech sector continues to pull down at these primary measures. The markets overall, are thus having a very difficult time sustaining rallies. 

Many might attribute the weakness in the markets as primarily the result of recent geopolitical developments, and perhaps they may be right. But as a Technical Analyst, I work very hard at segregating "exogenous" events, meaning events "outside of the market itself," and focus primarily, with near 100% concentration, upon price behavior or TRENDS in prices only. So, my explanation of why the markets are weak or strong may seem very odd to some. I have learned through the years that the less I focus on events outside the market, and the more I focus upon the trends in prices itself, the better off I am as an active participant in these markets. 

At the heart of the market's weakness this year is the tech sector. While it may have been four years since the market bottomed, in the grand scheme of things, the "crash" in the NASDAQ is still fairly recent – and yes, we can properly call it a crash, since it did lose 84% of its value from its high point in 2000 to its low in 2002. Now, the NASDAQ is still going through a very long "corrective" period to stabilize that "crash." The "rally" that started in 2002 is finally showing signs of tiring, and plenty of that overhead pressure from the "crash" is once again making itself known this year. Well, who else will get hit the hardest by this, but the tech-sector itself? 

Earlier, I mentioned that the heart of the market’s weakness is the tech sector. As we look deeper into it, we find that at the heart of that weakness in the tech sector is the Semi-Conductor sector. Here is an index that so far has lost 32% of its value since its most recent swing-high in January 2006. Nearly all of those losses occurred in the last 10 weeks. That's a lot to lose in that amount of time, so we can properly say this market is getting crushed. 

Another aspect of the markets that we have learned from the past is that the Semi-Conductor sector tends to lead the short-term momentum of the NASDAQ; and the NASDAQ, in turn, tends to lead the short-term momentum of the S&P500, which represents most of the actively traded issues in the US Equity Markets. Not all the time, but quite often enough, we find that the Semi-Conductor sector is "the dog" while the rest of the markets is the "tail." So most of our analysis this week is going to focus on what "the dog" is going to do. In other words, if the Semi-Conductor sector is leading the markets down, let's take a look this week at where we can expect some support in that particular market to come in, as quite clearly, everyone seems to be wondering when all this weakness is going to end. The charts seem to suggest: very soon. So, let's take a look:

Chart Notations:

• The Weekly chart of the PHLX (Philadelphia Stock Exch.) Semi-Conductor Index (popularly known as the SOX Index) above addresses the Short-to-Intermediate-Term time horizon. This is our third update in a row for this very same Market and Time Horizon, as we have been watching this market quite closely, as we should. 

• 2 weeks ago, the SOX broke a very important Trendline on the Weekly scale and has since dropped like a falling piano. The rate at which the SOX has lost its Bids since the high this year is the fastest, most violent sell off this market has seen since it bottomed in 2002 (take a look at the far left side of the chart, as we see the tail-end of that "crash" we were talking about earlier).

• SIDE NOTE: Many might observe that our chart above has developed a Double or 2x Top reversal pattern. In the classical technical definition of the 2x tops, this is really not an ideal example. The reason is that the 2x Top we see on this chart is dwarfed by a huge crash that preceded it (most of that is out-of-view of the chart). Well, we cannot have a 2x Top Bearish Reversal (popularly known as the "Double Top" Reversal) at the BOTTOM of a large downtrend – that would not make sense (this is a common novice trader error). As a result, it would not be appropriate for us to use standard 2x Top reversal measurements here. Instead, we will just use simple Support and Resistance both on the Horizontal and Diagonal scales – I have marked those accordingly.

• So, we have a market that is fast approaching a couple of very important Support lines on the Weekly scale. Over the short-term, the market is very oversold and thus risks to either direction are very high. As the market approaches support, short-term traders must be very careful as an upside reaction is imminent. The first support line is just a stone's throw away, and we should not be surprised to see a strong upside reaction at or very near that area.

• The SOX is the market that is leading the rest of the equities to the downside. Recently, we are seeing evidence that the rest of the NASDAQ's downside momentum is beginning to slow down. The S&P500 and DOW have been even more resilient. I feel that as soon as the SOX has found some good footing, the rest of the markets should get a strong upside reaction. Let's take a look:

Chart Notations:

• Relative-Strength Analysis: The Intraday Hourly Line chart overlay above compares the $SOX (Semi-Conductor, in BLUE) Index to the NASDAQ-100 (in RED). We address the very short-term Time Horizon here (up to 10 trading days, or 2 Calendar weeks)

• Notice somewhere in the middle of the chart, the SOX (blue) began to decline at a higher rate of speed than the Naz (red).

• On the bottom right-hand side of the chart, notice also that the SOX continues a decline to new low, while the Naz has been able to hold above the prior low – this is our first significant indication that the Naz is winding-up for an upside reaction. This will most likely occur when the SOX finally finds its footing (see prior chart). Let's see what a broader comparison looks like:

Chart Notations:

• Relative Strength Analysis: The Intraday Hourly Line chart overlay above compares the S&P500 Index (blue) to the NASDAQ-100 (red). We address the very short-term Time Horizon here (up to 10 trading days, or 2 Calendar weeks).

• Notice that right at the beginning of July (horizontal yellow line), the Naz detached from the S&P and began a faster rate of decline. Also notice that S&P500 has been holding strong in July, compared to the Naz which went to a new low (use the horizontal yellow line as reference point for Support on both markets). The S&P500 is showing a great amount of relative strength, and is therefore very susceptible to upside reaction.

• Our Relative Strength analysis here is very similar to the prior chart, except that we are just monitoring the tracks of broader measures. As soon as the SOX index (prior 2 charts) finds it's footing at support, this will create a domino-effect of upside reactions that result in a broad-based advance. Beginning this week, the market is very susceptible to this, so, let's keep this in mind in the days ahead.

Until next week: Good Luck!   Fernando Gonzalez

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Fernando has over 6 years of high volume professional trading experience, with a long-term track record of profitability. He helped develop the original material and coursework for Online Trading Academy. He has designed and individually conducted courses for over 400 trading students and several hundred others in Lectures, Forums and Intraday participation within the Day Trading Education and Advisory Community. He has also co-authored a best-selling book: Strategies for the Online Day Trader (McGraw-Hill 1999), which reached overall best-seller list on Amazon.com & section bestseller list for Barnes & Noble and other notable sources.

DISCLAIMER: 
This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results.

ABOUT THE WEEKLY REVIEW:
The weekly review heavily focuses on the application of Technical Analysis on the Broad Market Levels. You will rarely see individual Stock Picks on the Weekly Review! It is the author's belief that most Individual Stocks (certainly not all) will follow the overall direction of the Broad Market that surrounds them, as well as the Sectors they comprise. Discussion is focused heavily upon the Major Market & Sector price activity. Rarely also will you see discussion of the fundamental, macro-economic or political nature in the Weekly Review. By focusing only on the technical, or price & volume aspects of the major measures of the market, Fernando hopes to satisfy any equity trader's needs for a qualified discussion and forecast of the overall direction of equities, whether it be the Short, Intermediate, or Long-Term time horizons. Whether you trade the Index Futures, Index Tracking Stocks or Individual Equity Market Instruments, having an experienced eye on the conditions of the broad market that surrounds you is extremely important!

© 2006 Fernando Gonzalez
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