Trader’s Narrative

In 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):

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.

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.