Each week we find examples from the current market to illustrate the use of technical analysis for research. The chart below is the PHLX Semiconductor Index (SOX). There is plenty to learn from the chart since making a high in April at the 400 mark. Since that point the index made five attempts to hold support at the 324 level. Last week the index broke just below that mark to catch support at the 313 level which was the February low. The next support would be 307 and then 287, but 287 mark is the support should the major indexes (S&P 500/NASDAQ) break lower.

I want to put this chart in perspective for those who are still learning to use technical analysis. Over the last ten years I have returned to the simple approach to technical analysis. Why? Because it is easy to see and easier to build a trading strategy around. The strategies have a lasting quality to them as they work in most market cycles. Finding short term trading opportunities around support is a good example for this chart.

First, look at the trading range of 324 to 375. This range was in play until the bottom in early July hit 345 and bounced. It did the same two weeks later shortening the bottom of the range to 345. Thus, support went from 324 to 345 as the index traded sideways looking for direction or it was trendless. Note the 200 day moving average was also in the 345 vicinity. Thus, 345 was an important support level during July and part of August.

Second, what would happen if the price broke below support at 345? The next obvious level would be 324 and set up a potential trade opportunity to be short. The gain potential would be 21 points. The risk would be a move back above the 345 level with resistance at 355 or 10 points. The risk/reward is not the best in the world, but worth trading using SSG, ProShares UltraShort Semiconductors ETF.

Third, volume should move higher in relationship with the break lower in this example. On the second and third test of the support at 345 volume was higher by 60-100%. That is an indication buyers and sellers are fighting it out for direction. If the downside volume is higher and the price bar breaks support the entry is established.

Thus, the trade is set up based on a break of support at 345 on the SOX index with rising volume. The important point to make relative to this support, it had been tested three times prior to the break (twice on higher volume) below the 345 mark. Thus, it was a tested support level, and one if broken, would invite sellers to join in and push the index lower. As you can see the third test broke and closed below 345 on 60% higher volume, and equally important the price closed below the 200 day moving average. That established the entry bar for the short trade.

The index has continued lower since this break and continues to be an active trade based on a stop now at 318. If the stop is hit at 318 it would lock in a 27 point gain. Since you cannot trade the index you would equate the trade to SSG which can be traded. It is important to note the fund is 200% leverage and carries much higher risk for the trade.

Building a strategy for trading short term on the break of support lines on the downside is a beneficial tool to use in a down trending market. In up trending markets you would look to play a bounce off support to the upside on rising volume. The trend of the major index or broad market index is important for which strategy to deploy. Volume is the other indicator you would want to combine with this strategy. If volume is below average on the bars breaking down, wait for volume to be 20-50% above average (50 day simple) before taking the risk of the trade. This is equally true in an up trending market playing a bounce to the upside. If volume doesn’t jump, pass on the trade. There are too many opportunities to force a trade.

If you have questions about this example, feel free to send an email to info@sectorexchange.com and we will be happy to assist you. Watch for the ETF Spotlight to cover this in video format, as I explain further how to look at support trading opportunities.