Chip Stocks Look Ripe for a Pullback

Chip stocks are moving well these days, playing furious catch-up with the broader market. However, I think the charts suggest a selloff is near that could put a damper on the fall rally.

Let's review the sector's progress since its October low.

After a selloff to $32.50, the Semiconductor HOLDRs Trust (SMH - commentary - Cramer's Take) has moved higher four weeks in a row. The exchange-traded fund broke a three-month falling trend line last week and hovered just above that level during Friday's abbreviated post-holiday session.

Accumulation measures during the monthlong rally have been moderately bearish, with on-balance volume failing to reach the August peak that preceded the two-month selloff. The trust is now moving into this resistance level, suggesting chip stocks are nearing an important crossroads.

Indeed, what happens now is critical to the survival of the uptrend.

The sector's current challenge is easier to see on the Philadelphia Semiconductor Index. Though they have roughly the same number of components, with 19 in the SOX and 20 in the trust, only 13 components are common between the two, making them entirely different animals.

Variations between these instruments are natural, and I believe the trust is a better read on sector action because it's tradable. In essence, that makes it a quasi-futures market for chip stocks.

There's a difference between their charts right now that's catching my attention. The trust's trend line breakout is barely visible on a weekly SOX chart. Instead, we see an unstable rally into triple-top resistance. This level is especially dangerous because there have been few pullbacks in the rise from 413 to 487. A selloff to fill the Nov. 18 gap makes perfect sense right now.

A quiet piece of news from Wednesday afternoon may be the strongest signal on the sector's short-term direction: UBS Securities downgraded Broadcom (BRCM - commentary - Cramer's Take). Broadcom is the sixth-largest chip company in the world; UBS is the biggest program trader. This type of release doesn't come out just before a holiday unless UBS is sending a message to other institutions.

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At the time of publication, Farley was long PLXS, NVDA and LRCX, although holdings can change at any time.

Alan Farley is a professional trader and author of The Master Swing Trader. Farley also runs a Web site called HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback; click here to send him an email. Also, click here to sign up for Farley's premium subscription product The Daily Swing Trade brought to you exclusively by TheStreet.com.

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