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Recommended
Technical Analysis of Stock Trends
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Rising
Wedge
Technically speaking, a
rising wedge in a downtrend is a decline to a new low on strong
volume, several weeks of narrowing, range-bound trade characterized
by higher highs and higher lows with contracting volume, followed
by a sharp break lower on strong volume.
Why Does It Happen?
Rising wedge formations in downtrends are very similar to other triangle
patterns in that they are characterized by narrowing price ranges
and slowing volume. There is one important difference,
unlike symmetrical and right angle triangles, rising wedge
formations in downtrends almost always result in large price declines. Many bearish technical patterns are
about deception and this is particularly true for the rising
wedge. Because this pattern features gradually higher stock
prices many investors will jump to the incorrect conclusion that
the stock is acting well from a technical perspective. This
is false. Although prices continue to rise, every rally is more feeble than the last
and it soon becomes clear that interest in owning the stock at higher prices
is waning. The first point in every rising wedge in a
downtrend formation begins with a relative new low. This low
is generally in response to a series of negative fundamental
developments. The stock may have had an earnings warning,
product delay or litigation setback but the story behind the price
weakness is always legitimate and leads to a real change in the
way the stock is perceived. What makes the pattern
interesting is that like many reversal patterns, the decline to
relative new lows actually leads to what appears to be aggressive
buying by large investors. This turn of events creates a
short term bottom (a). Encouraged by the show of strength at
point (a), selling pressures begin to wane and over the next
several days the stock begins to move higher. Volume is
light but it soon becomes clear the panic that lead to the recent
relative new low has been replaced by more rational
thinking. Wall Street brokers begin to make more positive
comments and volume increases modestly. This increase in
volume should lead to further gains but instead sellers step-up
and what looks like a reaction high occurs, point (b). On
continued light volume the stock drifts lower but to the great
delight of those looking for a near term bottom, the move lower
does not eclipse the lows set at point (a) and a new rally
begins. This point, (c), plays an important role in investor
sentiment because it appears as though the stock is making a
series of higher lows. Speculators begin adding new long
positions in anticipation of a much bigger rally -- and for a
short time they are rewarded. Amid more optimistic comments
from Wall Street analysts the stock rises beyond the level of
point (b) but not high enough to create a parallelogram with the
lows. This is a defining point in time because it sets the
wedge formation characterized by a narrowing price range.
After several additional sessions the stock stops rising and a new
short term top becomes evident, point (d). It is at this
point that a new, negative fundamental development occurs and the
stock begins to decline. Speculators rush to close long
positions to avoid losses but buyers are few. The imbalance
between motivated sellers and willing buyers leads to a watershed
decline. This situation is made worse by a series of
negative comments from Wall Street analyst in the days
ahead. Weeks later the stock declines to a new
low.
How are
Technical Targets Derived?
Technical targets for rising wedges
are derived by subtracting the height of the pattern from the eventual breakout
level. The breakout level is the lower trend line of the
triangle.
Rising Wedge
for QLogic
Vital Signs
-
Rising wedges can
be either reversal or continuation patterns. When they
occur in a downtrend they are always continuation patterns.
-
Although the news that is pushing the
stock higher may be bullish, weak volume is an indication that
professionals are not buying, indeed, these investors are using
strength to unwind existing long positions and/or establish new short
positions.
-
Rising wedge
formations in downtrends are distributive in nature. The
fact that price is rising but volume is declining is a good
indication that the move higher is illegitimate.
-
Downside breakouts
often lead to small 2-3% declines followed by an immediate
test of the breakout level. If the stock closes above
this level (now resistance) for any reason the pattern becomes
invalid.
bearish
pennants 
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