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Wedge Patterns

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I got a SUBSCRIBER E-MAIL asking me to explain what a bearish 'rising wedge' pattern is. This came up due to my musings in my most recent (4/30) Index Trader column to the effect that chart pattern of the S&P 500 (SPX) looked a lot or a bit like such a 'wedge' formation.

There was another question I received as to whether the S&P 100 (OEX) had or was forming a bullish inverted or reverse Head & Shoulder's pattern. I'll answer this one first after the following note about my most recent Index Trader column.

My other column: my INDEX TRADER articles:
This Wednesday Trader's Corner article also serves as an adjunct to my weekend 'Index Trader' column, an online (only) section at the Option Investor.com web site; bookmark or add to 'favorites' at this LINK.

In my Trader's Corner article I typically also do a brief technical midweek update to my weekend Index Trader. Especially so when I can demonstrate the technical/trader tools discussed here.

You will normally also see a web LINK to the Index Trader at the top of your weekend Option Investor Daily e-mail but was NOT the case for my most recent article of Sunday (4/30). This column can be seen by going to our web site using the above LINK when connected to the Internet.

S&P 100 (OEX) DAILY CHART: A possible (bullish) Inverted Head & Shoulder's pattern?

What is outlined below on the daily OEX chart does look EXACTLY like a reverse or 'inverted' Head & Shoulder's (H&S) bottom formation. The Head & Shoulder's is most often seen as a topping pattern where the middle 'Head' is ABOVE the neckline.

The Head & Shoulder bottom formation is the reverse or mirror image of the H&S Top: there is a minor rally and sideways trend (the left shoulder), a decline to a new low and enough of a sideway move after that to suggest an INVERTED or upside down 'head'. This is in turn followed by another rally and a sideways trend that forms the right shoulder. The highs made on the left and right shoulders forms a straight line even if it slopes up a bit and this is the 'neckline'.

A decisive upside penetration of the neckline leads to a further advance that, at a minimum typically, is equal to the distance from the tip of the head to the 'neckline' which, if it happens, would give an upside target to 615.

All well and good EXCEPT that a reverse/inverted Head & Shoulder's suggests a bottoming pattern after a decline of some duration. NOT a pattern that forms after an uptrend going on since the October low of last year. Some technical analysts will say definitely that 'without a prior downtrend to reverse, there cannot be a head and shoulders bottom formation.'

However, me I'm struck sometimes by possible unconventional interpretations. It's remotely possible that this pattern shown on the chart above will turn out to meaningful as a way to measure a possible 'minimum' upside objective for OEX, assuming that the Index breaks out above the 598 level of the current neckline.

Summing up: the inverted Head and Shoulder's pattern is not usually seen as part of bullish 'consolidation' pattern, prior to another (upside) break out in the direction of a long standing up trend.

FOR COMPARISON - the HEAD & SHOULDER'S TOP
The following historical chart (the date at the top was when I ran it last year, the period shown was well before that date) is presented. The lower dashed downward sloping (cyan) line connects the lows of the Left and Right shoulders of the H&S top pattern and is considered to be the 'neckline'.

The distance from the tip of the Head to the neckline in the Q's chart below is distance 'a'. That same distance measured from the pierced neckline down is noted as 'b'; hey, the classic 'a = b'!

'WEDGE' PATTERNS ON CHARTS -
Wedge patterns are usually 'reversal' type patterns, suggesting that the existing trend is susceptible to a trend reversal. One such pattern, while not seen all that often, but which tends to be predictive for a bottom or top is the rising or falling 'wedge' pattern.

The wedge pattern of a "rising" bearish type is usually seen after an uptrend has been underway for some months, whether in a stock or an Index. [Sometimes, not as often, a wedge formation will suggest a potential trend reversal even before the emerging trend has gone on very long, such as just a few weeks.]

BULLISH FALLING WEDGES AND BEARISH RISING WEDGES -

In a rising wedge, prices move gradually higher but form converging trendlines and a "narrowing in" pattern of higher highs and lower lows, such as seen in the TWO opposite wedge pattern shown below; the first, that of a rising wedge, as seen in the daily Dow 30 (INDU) chart back in mid-2004.

I don't remember seeing a back to back example like this in an Index, where a rising wedge was followed by an opposite bullish 'falling wedge':

The upward sloping or bearish wedge is normally bearish in its implications for future price action. There is a "measuring" rule of thumb for a price objective also; in the case of the bearish rising wedge seen above, prices should decline to the start of the formation, or at least to the lowest prior low. This is only a 'minimum' downside objective.

The wedge pattern should have at least 2-3 upswing highs and downswing lows that comprise the points through which the trendlines are drawn the more points than this minimum number the better, in terms of drawing two well-defined converging lines.

What is being suggested in the rising, bearish wedge is that buying is being met with stronger and stronger selling as prices edge higher. When prices fall below the lower up trendline that of a rising wedge pattern, a trend reversal is suggested prices may rebound to the trendline again, but will typically not get back above it.

CURRENT LOOK AT THE S&P 500 (SPX) CHART:
A possible bearish rising wedge pattern, suggesting a top?

Well, the pattern in the S&P 500 (SPX) chart looks a lot like a bearish rising wedge. This is speculation unless or until the lower rising trendline is pierced at its current intersection at 1294.

If this were to happen the outlined pattern below, interpreted as a bearish rising wedge, would have given advance warning technically of a significant top with an ultimate downside objective at least back to the 1255 area. Stay tuned on that!

I should also note that technically for the SPX index as seen above, the intermediate trend would not be considered to have reversed until and unless the prior 1286 low Close was exceeded.

There was another example of a bearish falling wedge pattern setting the stage for an upside reversal, in the QQQQ chart for the early part of the year I used in an article a couple of years back. The implied 'measuring' implications of the wedge, as back to the start of the (falling) wedge formation, was just fulfilled:


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