This bearish 'key reversal' chart pattern could be why chip stocks suffered a rare selloff

By Tomi Kilgore

A textbook pattern warns of a change in trend for the red hot Kospi composite, which has recently mimicked the PHLX Semiconductor Index to a T

A bearish chart pattern in South Korea's Kospi Composite Index could act as a warning for the U.S. chip sector, given that the two have moved in sync during their recent sharp run-ups.

Financial markets by their nature don't follow a script, so chart watchers can't help but get excited when they see a textbook chart pattern appear in a widely followed index.

South Korea's Kospi Composite Index KR:180721 has been red hot, particularly since the end of March, fueled by the parabolic gains in shares of memory-chip makers Samsung Electronics (KR:005930) and SK Hynix (KR:000660), which combined account for nearly half of the index's total weighting.

But on Tuesday, volatile trading due to fears of a potential tax on profits generated by artificial intelligence produced a bearish "key reversal day" pattern, with the index falling 2.3%.

That pattern, also known by the more ominous-sounding "bearish engulfing," followed the description in technical-analysis textbooks to the letter, to warn of a change in trend.

The key reversal is a two-day pattern. First there's a strong move to a new high, the more significant the better. The Kospi shot up 4.3% on Monday to a record close. Second, there's a gap higher the next day - to open above the previous day's intraday high - then a further rally to a fresh intraday high, before a sharp reversal to close below the previous session's low.

The following chart shows that the Kospi followed that to a T.

As Oppenheimer technical analyst Ari Wald put it, the reversal in the Kospi was a "near-term sign of fatigue following a bullish rally."

He said that while the Kospi was certainly due for a pause following its recent run - it rallied 48.2% from March 30 to Monday's record close - he believes it may be premature to think the uptrend is reversing.

That warning was loud enough to hurt U.S. chip stocks, as the PHLX Semiconductor Index SOX dropped 3% on Tuesday, just the fifth loss in the 30 sessions since March 30, with 29 of 30 components losing ground. A reason for the selloff in sympathy with the Kospi could be that an overlay of the two indexes shows that they've pretty much mimicked each other during their latest run-up, as well as over the past year.

The correlation coefficient between the two indexes since the SOX hit its most recent low on March 30 is 0.98, according to a MarketWatch analysis of FactSet data, in which a reading of 1.00 would mean they move exactly in sync. The correlation over the past year is 0.95.

Mark Newton, head of technical strategy at Fundstrat, said that while the recent rally in the SOX has been historically extreme - it had rocketed 69.1% from its March 30 low to Monday's record close - it hasn't come with the same degree of euphoria that would warn of an intermediate-term top. But he did warn investors against becoming complacent.

"These kinds of moves can't last; however, they're also quite difficult to fight," Newton wrote in a recent note to clients.

He said there are signs that showed, prior to the Kospi's reversal signal, momentum indicators had reached "extreme levels" on the long-term charts.

While that doesn't suggest investors should sell right away, he said history shows that during times of similar overbought readings led to "meaningful consolidation" at a minimum.

-Tomi Kilgore

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05-12-26 1642ET