I wrote about the rising 'Wedge' pattern last week (1/14/10) but was asked if I would elaborate on how this type of triangular shaped pattern compares to other chart patterns that are called various types of Triangles
There are a number of different classes of reversal type patterns described in charting/technical analysis, including the recently completed bearish rising wedge. Unlike some of the other 'classes', this formation doesn't usually suggest more than an intermediate pullback.
A RISING WEDGE PATTERN:
I wrote a bit on the wedge pattern in my weekly (Saturday, 1/14/10) Index Wrap column by way of explaining my shift to a bearish trading stance:
"You might think that the rising wedge pattern seen on a stock or index chart, with its lower up trendline rising strongly UP, should be even more bullish than when prices are only in a gradual rise. But this is not usually the case. In a 'rising wedge' there is no evident barrier of supply to be vaulted but rather a gradual petering out of investment interest."
I'm going to expand on this previous comment a bit. I also went on to say this past weekend:
"In the Rising Wedge, prices advance but each new up wave is feebler than the last. Finally, demand fails significantly and the intermediate-term trend reverses. The major trend does not usually reverse, but in trading index options we're not focused on the MAJOR trend normally."
I'll show one example however, in a stock (GE), where a bearish rising wedge did precede a primary trend reversal and represented a major top.
The 7 classes of chart patterns that will be more or less familiar to you and that appear at more or less important reversals of trend direction are:
1. The Head & Shoulders
2. Multiple or Complex Head & Shoulders
3. Rounding patterns (tops or bottoms)
4. Symmetrical Triangles
5. Right-Angle Triangles
7. Double/Triple Tops and Bottoms
According to Edwards and Magee (Technical Analysis of Stock Trends), which I'm also in agreement with (more or less!), reversal types 1, 2, 3 and 7 develop most often at major turning points in the market or in a stock(s). Pattern types 4, 5 and 6 are more frequently seen at intermediate turning points and forecast intermediate pullbacks or rebounds.
Types 1, 2, 3 and 5 give an indication before they are completed as which way the price trend is likely to proceed after the formation of these patterns. (Numbers 4 and 6 give NO such indication and may signal continuation or consolidation of the trend rather than reversal)
The Wedge pattern is a chart formation in which the price fluctuations are confined within converging straight (or almost straight) lines, but DIFFER from a Triangle in that BOTH boundary lines either slope up (bearish rising wedge) or slope down (bullish falling wedge). The other difference is that typically the wedge pattern suggests something less than a major reversal of the dominant, what Dow called the 'primary', trend.
Looking at a bullish example of the Right-angle Triangle (# 5 above on the list), seen below, with its one horizontal and one UP trendline, you could easily conclude that the Rising Wedge, with BOTH of its trendlines rising fairly steeply, would be even MORE bullish. However, this isn't the case. First, the chart below is an example of a Right-Angle Triangle, the bullish version of which is called an ascending triangle. The commentary on the chart speaks for itself.
The flat top of an 'ascending triangle' seen above suggests that a large supply of the stock, in this case Apple Computer (AAPL), was for sale just under or around $100. The horizontal/level line signifies a supply of shares being sold at a fixed price; when that supply of the stock has been absorbed and the rising lower trendline representing increasing buying interest indicates it WILL be absorbed, the (supply) pressure is off and prices then rose substantially higher.
In a Rising Wedge, with BOTH of its trendlines pointed up, there is NO evident barrier of supply to be vaulted. This pattern instead suggests a gradual petering out of investment interest. Prices advance for sure, but each new upswing carries less far than the last. Finally, demand fails significantly or just collapses and the trend reverses. As I pointed out before, in a 'technical' sense this situation is one which is growing progressively weaker. My next chart is of General Electric in the 2007-2008 period. As is characteristic of the formation of 'most' Wedge patterns, the pattern is seen primarily on the daily charts:
THE BEARISH RISING WEDGE:
The Wedge pattern, of a rising bearish type, is usually seen after an uptrend has been underway for a while, often when an intermediate to long-term up trend is quite well developed which is certainly true in the current market trend.
What also sometimes happens with an initial break of an important trendline, prices subsequently rebound back to the same trendline, but are not able to resume its prior rate of upside momentum. For this reason I've noted, via the red down arrow, where I think the initial area of resistance would be found on a rebound.
The Wedge pattern that formed from early-November until recently as seen with the S&P 500 (SPX) chart below, was what turned me bearish late last week ahead of this recent break. Why bother with technical analysis if it doesn't tip you off to stuff BEFORE it happens. I found analysis of chart patterns that suggest a reversal ahead as a best way (for me) to buy options that are reasonably priced before a large reversal type move occurs. I used to short the S&P 500 futures ON a break but learned the hard way not to try to buy index or individual stock puts that same way. Live and learn!
The notations on my SPX chart suggest a 'maximum' downside objective for a pullback. Right now I find it hard to believe that a correction will carry that far, but it will likely take a substantial correction before a more bullish sentiment reading occurs in terms of my (CPRATIO) indicator seen at bottom. The bulls haven't had a big scare in a long time and one may be 'due' so to speak.
The difference between a Rising Wedge and a 'normal' Uptrend Channel is that the Wedge sets a sort of limit on an advance. Its conversing trendlines focus on a point near where the advance will stop and a reaction set in.
ESSENTIAL FACTS: RISING WEDGE PATTERNS
1. The Wedge can develop either as a type of 'topping out' pattern to a previously existing uptrend, or start to form at the bottom of previous downtrend.
2. The Wedge normally takes more than 3 weeks to complete.
3. Prices almost always fluctuate within the Wedge's confines (between the two rising up trendlines) for at least two-thirds of the distance from the base (beginning of convergence) to the 'apex'.
In some cases, prices go a short distance beyond the apex, pushing out a top in last gasp rally attempt before collapsing.
4. Once prices break out below the lower trendline, they waste little time typically before a sharp decline.
5. The ensuing drop often or 'ordinarily' retraces all of the ground gained within the Wedge itself, and sometimes more. Stay tuned on this! The aforementioned ultimate price objective is one that's seen more commonly in individual stocks than in broad indices; e.g., the S&P 500, the Nasdaq Composite.
GOOD TRADING SUCCESS!!