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Comparing Wedge Formations: Then & Now at Trader’s Narrative





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technical analysis of stock trends edwards magee.jpgIn April we played an easy guessing game to point out the strange similarities that the stock market is exhibiting almost to the day, six years apart.

Since then the similarity is even more striking as the S&P 500 index is in a clearly defined wedge formation. That’s why I decided to pull out my trusty “Technical Analysis of Stock Trends” by Edwards & Magee - the classical and definitive work on technical analysis - to see what they say about this formation. Here’s an excerpt from the pages they dedicate to the topic:

The Wedge is a chart formation in which the price fluctuations are confined within converging straight (or practically straight) lines, but differing from a Triangle in that both boundary lines either slope up or slope down. In a Rising Wedge, both boundary lines converge, the lower must, of course, project at a steeper angle than the upper.

It can develop either as a sort of Topping-Out Pattern on a previously existing uptrend, or start to form right at the Bottom of a preceding downtrend. It normally takes more than three weeks to complete… Prices almost always fluctuate within the Wedge’s confines for at least two thirds of hte distance from the base (beginning of convergence) to the apex; in many cases, they rise clear to the apex, and in some, they actually go a short distance beyond, pushing on out at the Top in a last-gasp before collapsing.

As a final note, we might add that the Rising Wedge is a quite characteristic pattern for Bear Market Rallies. It is so typical, in fact, that frequent appearance of Wedges at a time when, after an extensive decline, there is some question as to whether a new Bull Trend in in the making, may be taken as evidence that the Primary Trend is still down.

We can clearly see the definition of a rising wedge formation being realized on the chart. I don’t think there is any equivocation (if you disagree, let me know what you think the formation is):

wedge formation March 2009 rally

And it looks very similar to what we saw exactly 6 years ago. With a few exceptions. Not shown on the chart is what happened immediately after May 2003. The S&P 500 continued to go higher, then lurched lower to retest the 920 level. This action broke the lower trend line and made many believe that a text-book wedge formation was playing out. I was one of them, by the way. Of course, it didn’t. Just as abruptly, the market again turned up and never looked back.

wedge formation March 2003 rally

To explore why, I want to concentrate not on the similarities between the two scenarios but the differences. For starters, the 2003 wedge formed above a previous low (October 2002). Related to that, the long term moving average (200 day simple) was not only flat and turning up slightly, it was below the pinnacle of the wedge. Finally, 960 was an area of resistance for the index and when it was clear, there was nothing but “blue sky” after a lengthy base.

Right now I’m more focused on those differences and as I pointed out before when we looked at the market through Weinstein’s stage analysis, we need to do more back and filling before this bear is really over. I would be very surprised if the market didn’t look back from here. Shocked more like it since it would be the second time in 6 years it had fooled me in the same way!

To prevent that, I’m relying on an indicator which I didn’t know about back then: the Coppock Curve. Of course, even if the Coppock guide gives us a rare and valid bullish signal by month’s end it wouldn’t negate this scenario from playing out:

…the market falls once more but not beyond the swing lows it has already marked. This allows for the sideways action or basing which ameliorates the steep slope of the 200 day moving average and eventually sets up for a final push which takes price, along with the 50 day moving average, above the long term average.

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21 Responses to “Comparing Wedge Formations: Then & Now”  

  1. 1 Michael

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    The biggest (and in my opinion, the most important) is the S&P’s 200 dma. Notice the very different pictures from 2003 and now. These are 2 very, very different markets. More time has to pass for this market to have a chance to heal. Look at the 2003 market in late Nov. early Dec. That is probably closer to where this market is now. That’s if this rally is real. And I don’t have to tell anyone that is a BIG “if”.

  2. 2 Babak

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    Michael, that’s pretty much the way I see it. The nagging feeling I have is that pretty much everyone is resigned to the same conclusion! I don’t really sense a debate or real fight about this… and as a contrarian that makes me uneasy!

  3. 3 badcompany

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    Babak
    For this:” the long term moving average (200 day simple) was not only flat and turning up slightly, it was below the pinnacle of the wedge. Finally, 960 was an area of resistance for the index and when it was clear, there was nothing but “blue sky” after a lengthy base.”

    I’d like to point out both QQQQ and EEM (Emerging markets ETF) have already broken out of the resistance and are in “blue sky” area, and are very close to rise above their 200 moving average lines. I believe it’s too early to dismiss the possibility of another history replay.

  4. 4 Babak

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    badcompany, thanks for pointing that out, the Nasdaq is way ahead and so are emerging markets like Brazil. Will that be enough for history to repeat?

  5. 5 Paul

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    This is a great article at the right time. Something big is about to happen and only hind sight will tell. I have 2 questions. 1. what S&P numbers correspond to the swing lows? 2. Why does Coppock guide need to wait until end of month to declare a bull when recent S&P closes have been above the 876 required for month end? Many thanks in advance. I would also add a major difference this time is massive Government intervention and changing accounting rules in the middle of a game. How can you play the same game and expect the same outcome if rules are no longer the same. It could be a new frontier but government money can not last forever. I hope Weinstein will prevail over the current bulls.

  6. 6 Babak

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    Paul, by swing lows, do you mean the October ‘02 lows? The reason we have to wait for the month’s end is that the Coppock curve is calculated monthly. It moves very slowly and rarely gives signals. Government has always been a part of the market and if you believe in the functioning of markets to aggregate all data, that’s just another variable.

  7. 7 SAN

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    I think you did not fall into a trap in 2003. A wedge pattern is simply what it is: a pattern. Every pattern can have some kind of expectancy which includes by definition a positive and a negative outcome in relation to each other. In 2003 it was just the negative. Your analysis was still right…
    Maybe one culd have been more cautious because in 2003 the wedge did not play out from a major low as we experience this year.

  8. 8 Jim

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    Babak, thanks for another excellent post.

    I think another key thing separating the 2009 rally from the 2003 rally is volume, as illustrated by Hussman

    The SPX is butting up against the bottom of the wedge, so I guess this eerie similarity continues…

  9. 9 Babak

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    Jim, yes volume is different, thanks for the link to the Hussman article. I mentioned it a while back when we looked at the differences between this and previous rallies.

  10. 10 Paul

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    Babak, since S&P closed at 776 Oct 19, 2002, your scenario if the market currently at 908 pulls back it will not past 776, yes? There has to be a catalyst against a lot of bulls out there. First coverage tracks sell side sentiment wrote last week a sentiment change is coming. Thank you again. I have learned a lot reading your articles and really appreciate it.

  11. 11 Babak

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    Paul, the scenario I’m proposing is that we head down again but not break 675 (the low in March)

  12. 12 W. Peary

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    What’s the status of Lowry’s 90/90 down days going into the March lows, and 90/90 up days in the following rally? I’m not aware we had either 90/90 down or up days. Did we? This should indicate whether we’ve seen a real capitulation bottom or not and a new bull market.

  13. 13 Babak

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    W. we’ve had 90/90 days up the wazoo during this bear market. The more important question is how is their proprietary BP/SP? Last note I saw from Lowry’s their buying power and selling pressure was starting to move out of “bear market” mode which is critical.

  14. 14 Paul

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    Babak, S&P up 3% today 5/18 and the broken Up trend wedge went back to the lower channel. Seemed market just wanted to go higher? Some articles said lowest volume since January. Any insight on this move like surprised or expected? Thanks.

  15. 15 Babak

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    Paul, I think in the short term we’re seeing churn as the two forces oppose each other and pretty much cancel out. Price is bumping up into the overhead resistance represented by the previous tops and the declining 200 day moving average. I’d get bullish again if it can reach above 930 and definitely over 940.

  16. 16 Paul

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    Thank you Babak. 940 is about 200 D MVA. 930 is 5/8 top. Yesterday closed at 908 just below the lower wedge channel of the Up trend wedge. We are close to a turning point. We’ll see. Sell off intraday yesterday at the close did not surprise me.

  17. 17 Paul

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    Babak, Trim tab said 2003 the economy was actually improving and the current economy is deteriorating. Would you call today’s action a shooting star, popped to 826 and closed at 803? It’s a real suspense…

  18. 18 Babak

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    Trim Tabs doesn’t have a great record. Ritholtz shreds their research continuously.

    Today’s SPX candlestick pattern was really negative. A reverse hammer or shooting star as you mention. Usually appears at tops.

  19. 19 Paul

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    Babak, S&P closed 8 days below the lower channel of the Up trend wedge. Moreover yesrterday’s 888 and today’s 887 closed below the 20 Days MVA. It is vey likely it will go lower as recent sell offs at close along with a tired story of green shoots vs. record 6.5 millions unemployed, another 1.4 millions grads according to BLS, big loss of wealth, etc should weigh on the consumers.

  20. 20 Paul

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    Babak, S&P going to 875 tomorrow is not likely so the Coppock guide will give us a valid bullish signal. Interesting, S&P wants to go up although unemployment, foreclosures, delinquencies, 10 year rates are very high and will likely go higher. Do you still think “the market will fall once more but not beyond the swing low”? Any insights?

  21. 21 Babak

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    Paul, the market is shrugging off every single negative news. Swine flu? unemployment? earnings? GM bankruptcy? etc… I’m still hanging on to the thesis of a retest of sorts to give the long term moving averages time to mellow out.

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