AI is the hottest trend in the market right now.
Investors have piled into stocks like Nvidia (NVDA), Taiwan Semiconductor (TSM), and Broadcom (AVGO) all year.
These are just a few of the companies that traders think will benefit the most from the AI craze. So far, they’ve been right. They take up a good chunk of the VanEck Semiconductor ETF (SMH).
SMH has been on a blistering rally since May of this year. It’s up 18%.
But before you decide to buy into this rally now, be aware. My analysis shows the trend for semiconductor stocks is about to end…
Right now, the price charts show trouble ahead.
Whenever a market takes off, a lot of folks fall victim to FOMO (fear of missing out).
Seeing a stock trade higher and higher is just flat-out painful. Eventually, ill-disciplined traders (or investors) cave in and decide to buy… often at exactly the wrong time.
This is how you get parabolic moves (when a stock trades up in a straight line). But this requires traders to keep buying high, thinking they can sell at even higher prices for a profit.
Eventually, folks get nervous or realize that the stream of people willing to buy the stock is slowing down and they start selling. This can cause a panicked rush to sell.
The good news is that the warning signs are almost always there ahead of time.
The current chart of SMH is a great example. There’s a powerful reversal pattern that’s very close to triggering.
Let me show you on the chart below:
Two important things are going on with this chart.
First is the head and shoulders pattern that began taking shape back in June.
The head and shoulders is a classic reversal pattern that has three components: the left shoulder, the head, and the right shoulder. You can see these parts labeled on the chart.
Once the right shoulder is complete, you can draw a line connecting the bottoms of the left and right shoulders. This is known as the neckline of the pattern.
The pattern is complete once prices break below the neckline. Afterward, you can expect to see a swift, sharp sell-off.
The second important feature is known as bearish divergence. Bearish divergence occurs when prices continue to make new highs, but the Relative Strength Index (RSI) starts trending lower.
SMH didn’t peak until July 28. But the RSI actually put in its top on May 31. This is a sign of underlying weakness in the market.
Chart patterns are always stronger when paired with a technical indicator like bearish divergence.
Trimming some exposure to the sector, or even playing the short side, are both valid options. It depends on how aggressive you are as a trader or investor.
Either way, it’ll be important to keep an eye on SMH over the next few trading sessions. Because if you’re thinking about buying, my advice is don’t… not yet, anyway. A better opportunity is likely not far off.
Happy trading,
Imre Gams
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Source: Jeff Clark Trader