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Watch an Unlikely Chip Bellwether

This column was originally published on RealMoney on Aug. 3 at 9:08 a.m. EDT. It's being republished as a bonus for readers.

A few weeks ago I suggested that the Philadelphia Semiconductor Index, or SOX, had a pretty formidable downtrend line that came in around 470 , and that this particular area ought to act as a first resistance level.

And for two weeks the SOX has essentially milled around this 470 area.

So it was only natural that my inbox was flooded Tuesday with questions about whether this was a breakout.

As I posted the chart of the SOX last night, I must admit it was hard to see that the SOX actually crossed that downtrend line, owing to the fact that the area is so large.

I suppose if you are bullish and you squint hard enough and maybe get the magnifying glass, you could call that a breakout.

But if we look at a shorter time frame, what most folks might see is that we have run right smack into another area of resistance in this 485-490 area, dating back to the highs of June 2004.

All these resistance levels are not what I find so interesting here, however.

What I find interesting is the action in Analog Devices (ADI).

I know, I know, I can hear you now, telling me how Texas Instruments (TXN) or Intel (INTC) are more important stocks.

And you may be right. But I've been posting the chart of Analog Devices for as long as I can remember, and I had this sense that the stock had this tendency to be an early tell when it comes to the SOX.

So I did one of those comparison charts and as it turns out, you really can make a case for Analog Devices being a leader in this group.

In this chart Analog Devices is the black line. Point A on the chart represents last fall. You might need to squint to see this (the SOX is the yellow line), but in September of 2004, Analog Devices did not make a lower low, but the SOX did. However, that lower low in the SOX, being unconfirmed by this little-noticed stock, was a positive divergence, telling us that the SOX was OK down there.

Point B on the chart came in November of last year, where Analog Devices made a high and began heading lower, yet the SOX itself went on to make a higher high a few weeks later. That higher high in the SOX was unconfirmed by Analog Devices' chart. The SOX proceeded to fall from 450 to 380.

Point C on the chart came in early March of this year, as the SOX kept making higher highs while Analog Devices was already faltering. Point D is the April low and the SOX came down to retest its low in early May, but by then Analog Devices had no interest in testing its low. It was already making higher lows.

And that brings us to the current environment. The SOX is making a new high in here and Analog Devices has yet to do so. Then last night after the bell Analog Devices disappointed investors by warning of a revenue shortfall. Shares were trading at $39 recently in Wednesday's premarket. There is no timing to this, and like all indicators, it is not perfect, but perhaps the action in Analog Devices should be given close scrutiny because it seemingly has been giving us clues about the next turn in the SOX.

So if we draw in the uptrend line on the Analog Devices chart, we can see that $38 is an important level. So far each time I've highlighted one of these important levels, the stock has managed to hold in that area, so maybe Analog Devices will do the same. However, you can see why I think this relationship bears watching in here.

Overbought/Oversold Oscillators

For more explanation of these indicators, check out The Chartist's primer .

P.S. from Editor-in-Chief, Dave Morrow:
It's always been my opinion that it pays to have more -- not fewer -- expert market views and analyses when you're making investing or trading decisions. That's why I recommend you take advantage of our free trial offer to RealMoney premium Web site, where you'll get in-depth commentary and money-making strategies from over 50 Wall Street pros, including Jim Cramer. Take my advice -- try it now.

Helene Meisler writes a technical analysis column on the U.S. equity markets and updates her charts daily. Meisler trained at several Wall Street firms, including Goldman Sachs and SG Cowen, and has worked with the equity trading department at Cargill. At time of publication, she held no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. She appreciates your feedback; click here to send her an email.

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