Recommended
Encyclopedia
of Chart Patterns
staff
review of more
books like this
|
 |
Rising
Wedge
Technically speaking, a rising wedge in an
uptrend is a rally to a new high 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?
Like all reversal patterns, the rising wedge in
an uptrend is ultimately about deception. At first and perhaps even second
glance, the stock may appear to be doing all of the right things, making a
series of higher highs and higher lows. The flow of news is unanimously positive and Wall Street analysts fall over one another to raise estimates and
price targets, yet in reality, the stock is being distributed from strong hands
(longer-term investors) to weak hands (short-term speculators and less astute
investors). The pattern begins when a much loved stock moves to a new high after an extended advance on good volume. To be sure, momentum
investing and all around euphoria contribute to the surge in stock price but by
most accounts the fundamental outlook is solid. As the stock makes a new
high something peculiar occurs. Instead of volume surging, it actually begins
to contract and price falters, making a reaction low. Wall Street analysts
conclude that the stock is merely having a well deserved short term
consolidation after a lengthy advance and in the days ahead they reiterate
"buy" ratings. Once again the stock surges to a new high but volume
slows even further and very quickly price begins to fade. At this time the
news flow is excellent. The company may be raising guidance, unveiling new
products, winning contracts and/or setting stock splits. In short, it is
easy to be bullish -- especially when most investors share that
sentiment. But beneath the surface something is happening, the stock
is being distributed, longer-term investors are using every piece of good news to
reduce positions. As the stock falters for a second time the low achieved
is well above the reaction low and the chart begins to take on the appearance of
a wedge. After several sessions of consolidation more good news hits the
news wires and the stock surges to yet another new high. As was the case
during the previous two rallies, volume contracts. Then, abruptly price begins
to falter. Wall Street analysts remain steadfast because there have
been no fundamental developments to account for the weakness. Several firms
reiterate "buy" ratings, advising clients to use the weakness to build
positions but in reality, longer-term investors are continuing to sell.
This time the new bullish talk has little impact and price begins to free
fall. The bullish talk and positive news flow continue but it is just a
matter of time before the parameters of the wedge pattern are violated.
Soon after, support at the reaction low is violated. Several days after
the first negative news item hits the wires and speculators and recent investors
begin to panic, price plummets. Several weeks later the stock trades back to intermediate
term resistance.
How are Technical Targets Derived?
Rising wedges in uptrends are usually part of
larger reversal trends so the implications for the pattern are modest. Technical targets are
derived by subtracting the height of the pattern from the eventual breakout level. The breakout level
is determined by drawing a trend line drawn from the area of initial consolidation through the reaction
high.
Rising Wedge for Harrah's Entertainment
For most of the early part of 2001 Harrah's Entertainment (HET)
was a terrific stock. Riding a wave of strong earnings reports and rampant
bullish fervor, the stock surged to one new high after another on strong
volume. On April 18, 2001 Harrah's reported a 43-percent rise in first
quarter earnings and just days later the firm agreed to purchase Harvey's Casino
Resorts for $625 million. The stock surged to a new high at $36.75. But even
as the flow of positive news continued, volume began to contract and by April 30
the stock was trading back at a previous support/resistance level at
$33.75. Two days later Harrah's CEO filed to sell 101,144 shares in the
open market. Through the next three weeks positive news releases
continued. On May 15 Harrah's was just one of several gaming firms releasing record revenues and on May 21 the stock reached another new high at
$36.88 as news spread that the Nevada Senate was on the verge of passing
legislation that would make that state the first to offer Internet
gambling. However, even as the stock surged to new highs, volume
contracted. When a competing gaming company announced that it would
implement a surcharge because rising energy costs were hurting revenues Harrah's
followed all gaming stocks lower, reaching $34.75 May 29. Just days later
Harrah's signed a long term deal with energy producer Enron (ENE) and the stock
began working toward new highs. When Merrill Lynch reiterated its
"buy" rating for the stock on June 14 the stock was trading a fresh
new high of $38.20 but volume was very weak. Through the next week the
company released several positive news items but the stock price began to
falter. by June 25 the stock was trading back to $36. By June 26 the stock
back to the $33.50 level on no specific news. On July 3 the stock rallied strongly on news that "all star analyst" Jason Ader of Bear Stearns
recommended the stock as a recession resistant top pick with significant upside
potential. Three days later on July 6 Harrah's issued an earnings warning
citing the weak economy. The stock opened at
$29.50
Vital Signs
-
Rising wedges can be either reversal or
continuation patterns. When they occur in an uptrend they are always
reversal patterns.
-
Because rising wedges are generally just the
starting points for larger reversal patterns, the implied technical targets
are modest.
-
Volume is key in rising wedge patterns in
uptrends. Volume should increase on the initial surge to new highs but
dwindle through the remainder of the pattern. As the breakout occurs
volume should surge.
-
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.
Rising wedge in an uptrend is just one half of
the wedge
reversal family. Now let's take a look at falling wedge in a downtrend.
rounding
bottom 
falling
wedge
|
|
