I had a mild wake up call today when I had a quick-as-a-flash shift in my complacently bullish chart perceptions when I realized that I was looking at, but not really 'seeing', an evolving bearish chart pattern. One that could be a warning of a correction ahead, possibly a deeper one than I previously thought was in the cards.
Whereas I had been anticipating a continued rise within a bullish rising price channel, I started seeing instead a bearish rising wedge pattern.
As sometimes happens, I felt today I had nothing much of value that I could relay in a Trader's Corner piece. And, as per usual, I was going over my charts looking for something I hadn't seen before. In the case of today, I wasn't really expecting to find more than some minor technical aspect that could relate to the market trend ahead. Analysis of the trend is about all I ever write about.
Unlike the varied and sophisticated options strategy that Linda (Piazza) writes about (e.g., spread concepts, Volatility studies, etc.), I sometimes feel like a one-note band. I know intellectually that market timing (what I mostly do) is what has made me money. This was why I had a big following at UBS back when, etc. Nevertheless I was feeling pretty 'staid' in my thinking and that I didn't have much to report in terms of this sort of relentless advance we have been in. I love a strong trend but I get nervous when complacency, mine or others, sets in.
While the market has gotten to an overbought 'danger zone' and bullish sentiment is sort of off the charts to my way of thinking, I rely on chart patterns as the PRIMARY way to discern the trend. And I wasn't 'seeing' any chart pattern that suggested a possible upcoming trend reversal. The problem was that I was focused on my prior bullish perceptions and not taking a 'fresh' view of my charts. It sometimes happens that I see charts only within the parameters of how I've drawn prior trendlines.
I'll go to an example below of complacent thinking in terms of the way I had been marking up my charts. This is the way it unfolded today when I was looking at the QQQQ daily chart. I first zeroed in on the way the recent downturn in the OBV (On Balance Volume) line preceded the Tuesday-Wednesday dip. I thought about the predictive ability regarding trend shifts that indicator patterns sometimes have. My gaze was then drawn to the more steeply rising up trendline that has emerged, one taken note of in recent Index Trader commentary. This trendline shows the steeper rate-of-change in prices that has evolved since early-November.
And then I had this flash that, as the lower trendline of the broad rising uptrend channel no longer seemed particularly relevant, the UPPER trendline did NOT either. In fact if I connected the last four highs or cluster of highs, what emerged was a quite DIFFERENT pattern, that of a rising wedge, which is often a bearish omen; it is often called a bearish rising wedge; the reverse of the downward pointing bullish falling wedge.
Suddenly I was seeing a chart pattern that 'supported' so to speak, the bearish implications suggested by such overbought/oversold momentum indicators as the RSI (Relative Strength Index) and especially the bullish extremes in sentiment that have been suggested by my indicator for some time now.
I scrubbed the outlines of the broad uptrend channel that was so relevant LAST year and redrew a different set of trendlines on the same QQQQ daily chart, as seen next.
Moreover, in this sudden shift in my perceptions of the current trend, perhaps the recent rising QQQQ (see above) volume trend, within a basically sideways trend of the past 2+ weeks, stems partially from shorting activity or simply mostly reflects increased buying of the increasingly complacent bulls; e.g., no matter how far prices have advanced, they will keep going up.
THE BEARISH RISING WEDGE:
The opposite of patterns that tend to predict the continuation of a
trend, after a pause or consolidation, are ones that tend to predict upcoming reversals of the dominant trend. Of these, very well known are double and triple tops and bottoms, as well as Head and Shoulder's tops and bottoms. One seen less often, but that have often been predictive of an upcoming trend reversal, is a wedge pattern.
The wedges patterns of a rising bearish type are usually seen after an uptrend has been underway for a while, often when an intermediate to long-term up trend is quite well developed.
In a rising wedge, prices are moving higher but the various highs and lows form converging trendlines or a 'narrowing in' pattern of the highs and lows. There was an example, first used I think, in my (Essential Technical Analysis) book, of a long-term steeply rising bearish wedge in American Express. When prices broke below the AXP wedge pattern seen below, an expectation was that the resulting fall could carry back at least to the start of where the wedge began forming, which is what happened in this example.
Note that, as often happens with an initial break of an important trendline, prices subsequently rebounded back to the same trendline, but could not resume its prior rate of upside momentum. The wedge pattern seen here (with AXP) is an example of a steeply rising wedge as sometimes happens in a stock or market bubble.
Just to balance out the picture of both types of wedge patterns, an example of a bullish falling wedge is provided by this next chart, that of Novellus Systems (NVLS).
With the bullish falling wedge, once there is an upside breakout, there is also an expectation that prices will at least rebound back to the high point seen in the downward sloping wedge. According to Thomas Bulkowski's study of the wedge pattern in his Encyclopedia of Chart Patterns, an even higher percent of bullish falling wedges result in upside breakouts, versus the instances of downside breakdowns after formation of bearish rising wedges at least in stocks.
DYNAMICS OF THE WEDGE PATTERN
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 of a rising wedge pattern, a correction is often underway. Prices may rebound to that same, previously pierced, trendline again but will most likely not Close back above it or not for long as in the case of the AXP example above. Traders might place a liquidating buy stop just above the broken trendline, if a short stock position is established on upticks after the downside break.
When one index forms a bearish rising wedge, it is likely that the pattern will also be seen in the other major indices. I started this afternoon by seeing the rising wedge pattern in the Nasdaq 100 tracking stock, QQQQ. Besides the same pattern having been traced out in the underlying NDX index of course, a rising wedge pattern is seen in the S&P 500 (SPX) seen below as well as the other indexes (not shown).
If there is a decisive UPSIDE penetration of the upper trendline of the rising wedge pattern (seen below with SPX) by a sustained move ABOVE 1153-1154, the bearish implications of the wedge would no longer be 'forecasting' a significant top. If on the other hand, the LOWER trendline is pierced, this may represent the start of a more prolonged decline than the shallow pullbacks seen in recent weeks. What would set off such a move I couldn't say but trend changes always seem to have a precipitating event(s) or report(s) that market prognosticators point to.
A pivotal time technically usually comes when prices hit the APEX of the wedge, where the two lines converge. Here there is extreme price compression as represented in a progressively narrowing price range and an increasing balance in buying and selling. The market often tacks a new way after those rare instances of equilibrium.
The rising, frequently bearish, wedge pattern I've outlined makes some 'sense' to me now in terms of the related extremes seen in the RSI and (especially) trader sentiment seen above.
Stay tuned on the outcome of what looks like could be a pivotal juncture in the key index charts!
and ... GOOD TRADING SUCCESS!!