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Wedge Patterns: Another Type of Diagonal Triangle

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Question: Is there a distinction between a rising or lowering Diagonal Triangle after a respective up or down trend and the rising or lowering wedge after an up or downtrend, respectively?"


Before I answer this question, let me backtrack for others. For those who didn't see it, there's a reference here to my last (8/10/05) Trader's Corner; this column can be viewed in its entirety by clicking here

I was speculating on the possibility that the weekly Nasdaq Composite (COMP) might be tracing out an upward diagonal triangle. There are only 4 points or 'touches' to the two sides of 'triangle' formations so far; if less than 5 defining points however, the pattern is not called a 'triangle' typically. At least not according to the analysis of (R.N.) Elliott, who analyzed this type of pattern extensively.

Therefore, I was imagining a possible completion of a triangle by a COMP pullback to as low as the 2025-2000 area (making point 5 below), followed by a final move to a high for this advance; i.e., dating from late-2002 per the markings on the chart below:

When I wrote this and displayed the chart below, it seemed unlikely that the Composite would again dip below 2100. Stay tuned on that, as COMP closed yesterday (8/16/05) at 2137.

Some points about a "diagonal triangle' pattern relating to your question, as I think I understand it anyway:

1. The rising or falling diagonal triangle has both trendlines sloping up or down; versus the upper line sloping down and the lower line sloping up, which forms the more common 'horizontal' triangle.

2. Both the upward and downward sloping diagonal triangle usually form as the final 'consolidation' before a final run up to a new high or, fall to a new low, respectively.

3. Because this type formation is usually a continuation pattern; i.e., the trend will CONTINUE after the narrowing up and down price swings complete themselves ...

4. the slope of the triangle is in the (same) direction as the ongoing trend.

5. The breakout is UP in the case of the upward sloping triangle and DOWN in the case of the downward sloping triangle, which continues in the same direction as the prior overall trend.

The 'wedge' pattern is also an 'imagined' triangle, where 2 of he trendlines are lines connecting several highs and lows of price swings that carry less far each time; resulting in a projected apex or end point of the triangle that becomes narrower and narrower.

However, wedge patterns are typically REVERSAL type patterns. The wedge pattern slopes in the same direction as the prior trend. But, a rising or falling wedge implies a reversal of price direction ahead. And, the ENTIRE advance or decline, more or less, is contained WITHIN the trendlines.

The Dow 30 Average (INDU) formed an upward sloping wedge between the summer of 2004 and the early part of this year (2005). Once the lower trendline was broken, an intermediate INDU downtrend was signaled; e.g., a downtrend of several weeks and carrying back toward the area from which the index started tracing out the wedge:

The wedge example in the Dow chart above didn't quite achieve a decline all the way back to the prior low around 9800. But, hey, 10,000 was seen as 'the' magic number (for buyers) at the time and what's a couple of hundred points in the Dow anyway!

There's a point that I would make here: not to hang on for perfect objectives. INDU pierced its down trendline after reaching 10,000. This was around 101.8 in the Dow Index (DJX). It was then time (if not sooner) to exit DJX puts, and not to expect a final decline to the 98.0 area.

Back in March, I used the following chart example, also in the Dow Industrials (INDU), as showing back to back wedge type patterns in INDU:

Another historical example of a FALLING wedge can serve to illustrate a 'measuring' implication of wedge patterns:

On the chart below, I applied the measuring rule of thumb for a price objective on wedge patterns, where the next trend should at least get to the area of the beginning of the wedge pattern. In this example: to the highest prior top from the START of the wedge formation; only a "minimum" upside objective is implied.

TThe trend that follows can go well beyond this point, which has certainly been true in the case of the QQQQ (Nasdaq 100) tracking stock, which has advanced so far to as high at $40.

You may not always see a whole lot of difference between these triangles. But, the rising/falling diagonal triangle forms after a trend has gone for some time, has 5 highs or lows that touch the two lines and this is followed by a breakout above or below the triangle. br>
The wedge formation implies 'compression' of buying and selling interest as the price swings get narrower and narrower. The rising and falling wedge will typically be followed by a new trend that is in the opposite direction of the trend that has come before.

In my experience, the wedge reversal pattern, either of the rising (bearish) or falling (bearish) type, is more common in individual stocks than in the indexes.

I also find it a quite reliable pattern in the sense that this formation very often results in a sizable reversal. One taking the new trend back to where the wedge began to form; i.e., resulting in achieving the 'minimum' upside or downside objectives:



NOTE - br> PPlease send any technical and Index-related questions for possible use in my next Trader's Corner article to Click here to email Leigh Stevens Support [at] OptionInvestor.com with 'Leigh Stevens' in the Subject line.

Good Trading Success! br>  

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