The Oil Service HOLDR (OIH, $67.75) is an exchange-traded fund ETF) that holds a basket of companies involved in the oil drilling and service industry. As such, they are most profitable when oil prices and the economy are strong. Because the industry tends to be capital intensive and is characterized by extremely high costs (oil rigs, deep sea drilling, exploration), many of OIH's component stocks have relatively high debt loads. Therefore, high interest rates tend to put a damper on this fund. Meanwhile, a weak U.S. dollar is often a boon to these companies. Since oil is priced in dollars, a weak dollar increases the price of oil in dollar terms, thus improving company profits.

A quick note about HOLDRS...
HOLDRS, which are managed by brokerage giant Merrill Lynch, are a bit different from traditional ETFs in the way they trade and in their expense ratios. For example, you cannot buy or sell less than 100 shares of a HOLDR in any transaction. Instead, these unique instruments can only be traded in 100-share round lots. In addition, unlike most other types of funds, which track broad-based indices that contain hundreds (or some cases even thousands) of stocks, most HOLDRS consist of just a handful of stocks and are designed to track a particular industry group. Because they only track a few companies, HOLDRS are very inexpensive to manage. However, because they aren't highly diversified, they also tend to be much more volatile than the average ETF.

Many of the larger oil service firms are heavily involved in gas exploration as well. Therefore, many of OIH's components are integrated energy companies. Because of this factor, and because many different forms of energy can act as replacement products, OIH shows a strong 86% correlation to the Energy SPDR (XLE, $28.17). The fund provides an excellent means of diversification for a broader stock market portfolio, as its correlation to the S&P 500 sits at just 54%. Meanwhile, that correlation is well under 50% when you stack OIH up against the technology-laden Nasdaq indices.

As noted above, because HOLDRs are less diversified than most other ETFs, the Oil Service HOLDR tends to be more volatile than one would otherwise expect. OIH consists only 20 companies, and the top 10 holdings account for nearly 79% of the fund's value. Although no single stock dominates the fund, three individual companies each account for at least 9% of the fund's value. They are Baker Hughes (BHI, $35.08, 10.97%), Schlumberger (SLB, $61.18, 9.91%) and Halliburton (HAL, $30.15, 9.63%).

HOW TO MAKE MONEY IN OIH THIS YEAR
In terms of Elliott Wave analysis, the fund's wave count to its recent high is a slight concern. There is not a clear five-wave subdivision in what I would otherwise call a third-wave rally. OIH clearly broke out of a basing pattern in December, which is bullish. At a minimum, however, the fund should correct towards channel support, which currently sits near $66.00.

There is reason for some concern beyond the slightly sloppy pattern from November's lows:

• The dollar appears to be changing trend. This will hurt oil service firms.
• Momentum was not confirmed at the high.
• The weekly chart (not shown) shows that OIH is still in a larger range trade, with substantial resistance in the $70 to $76 range.

Until OIH can break above $76, there remains risk for a fall back into the lower or middle $50s.

While many analysts consider energy-oriented stocks a good defensive play, in the past OIH has been prone to major pullbacks when market conditions have turned sour. For example, during the most recent bear market the fund fell more than 50% from its issue price in early 2001, dropping from a high of $95 to its low later that year beneath $42. Although I doubt OIH will fall that low again, blindly buying this HOLDR for defensive measures could be hazardous.

For now, I recommend standing down from any holdings in OIH. Because other more overbought sectors will provide better shorting opportunities, I do not suggest shorting OIH either. If the dollar does not accelerate lower in the next month or two, then an attempt to purchase an underweight position in OIH near $64 -- just above the 38.2% retracement of the November-January rally -- with tight stops (say $61.20, the 2004 low) might make sense. Other than that, I'd steer clear of this fund for the time being.

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