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Keene Little : 10/14/2007 11:57:13 PM

I'm currently reading "Technical Analysis" by Charles Kirkpatrick and July Dahlquist. Chart patterns are covered and one of the more reliable ones is a wedge pattern, specifically the rising and declining wedge. Here's a copy of the rising wedge they show in the book: Link

They present some data to show when and how to play the various chart patterns and the wedge pattern is one of the more reliable ones. Declining wedges break out to the upside 92% of the time and rising wedges break down 82% of the time so we can see what kind of odds we're dealing with on this pattern. The authors suggest the pattern needs 5 points (for a rising wedge, 3 points at the top trend line and 2 at the bottom line) to ensure the pattern is correct. This correlates to a 5-wave wave count that I keep showing in these wedges.

Once price breaks down from a rising wedge the data shows a very low percentage of failures. In other words, playing the breakdown is a high-odds play out of a high-odds pattern. Look at the RUT daily chart I posted earlier and the example of a rising wedge above and notice the similarity. The following excerpt from the book should then make sense for why I'm looking for a high soon (if it didn't already occur last Thursday):

"Whenever a climax has occurred, whether up or down, look for a wedge to form on the test. This is one of the most profitable patterns of all. Any wedge, once defined, is usually profitable and has minimum risk once the breakout occurs."

Keene Little : 10/14/2007 10:09:04 PM

Assuming for now that we're going to get another leg up on Monday the question at that point is whether it will complete a 3-wave bounce correction of Thursday's decline or if instead it will be the middle of a larger rally to new highs. It's too early to tell but I would actually like to see the more short term bullish (pink) price pattern play out since it would coincide with the Oct 17 turn date. Link

The trouble with expecting more upside is the break down from the ascending wedge pattern (the uptrend line from Sept 25th). The final price high on Thursday, accompanied by the bearish divergences, followed by the drop below the pattern is typically a very clear and reliable sell signal. That's why the retest of the broken uptrend line on Friday was also an opportunity to get short.

But following that retest I didn't like the corrective pullback on Friday afternoon and that's what has me thinking we'll get another leg up to again retest that trend line up around 1570, which will be another short play setup. Bottom line, and to stay a little conservative this coming week (opex), waiting for a break below 1546 (which would also likely have the DOW breaking below 13950) might be a better short entry. If you like the setup I'd try a retest of the broken uptrend line but manage your play closely.

The daily chart shows that a break below 1546 would also be a break of the uptrend line from August 16th through its first pullback in Sept: Link

The RUT may be our better canary here since it hasn't yet broken its uptrend line from Sept 10th which is the bottom of its ascending wedge pattern: Link

Last week's pullback stopped at the uptrend line so that's now a key level--break below 804 and it should be lights out for the bulls. But until that happens we could see the market work its way higher to an October 17th turn date (an important one). The 60-min chart shows a potential price path up to the 858 area for a high: Link

Keene Little : 10/14/2007 10:07:24 PM

Monday's pivot tables: Link and Link

OI Technical Staff : 10/14/2007 9:59:59 PM

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