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Home > Opinion > Vanessa Drucker

By Vanessa Drucker | Published Jul 30, 2012

Technical omens now against FTSE

Wedge shapes in charts can be useful to investors who would like to incorporate a few basic technical tools into their analysis. The shapes are fairly easy to spot, and occur frequently, particularly during rallies amid broader bear markets. Most important, these chart patterns offer decent predictive value. (Be mindful however, that, as with all technical patterns, they sometimes fail. Otherwise we’d all be rich as Croesus).

For investors, wedges are relatively simple to identify. Take a line graph illustrating the performance of a market, mark off all the short-term tops that the market hits and draw a straight line through them. Next, do the same with the short-term bottoms. Lastly, check if the lines would converge in the future if they continued at their current trajectory. If they would, then a wedge shape is formed.

In general, some chart patterns indicate a market is consolidating, or a trend is continuing, while others hint at a change in the direction of prices. Wedges fall into the latter camp. Rising shapes amid rising markets suggest vulnerability to a fall, as market highs converge towards market lows. Descending shapes often fore-shadow a more positive turn, with market lows converging towards market highs.

It sometimes pays to look back, to determine whether prices have moved in similar recent patterns. The longer the trend has been established, the more meaningful a wedge will be

“From a demand standpoint, buyers are coming in where you would imagine, at the lower end of the channel. But sellers, on the supply side, are appearing sooner than expected, rather than waiting for prices to rise to the top of the channel,” says Chris Ciovacco, chief investment officer at Ciovacco Capital Management.

Alternatively, one might look at the same phenomenon as a gradual loss of enthusiasm, as each wave of buying interest becomes feebler than previous ones.

“A strongly trending market goes up without stopping. In a wedge contraction, as lines converge, it is a sign that sponsorship has died out and buyers have become exhausted,” describes Derek Gates, president of Sustainable Wealth Management.

Most likely, the pattern will resolve after prices have completed at least two thirds of their journey toward the apex, although sometimes they will travel all the way there, or even slightly beyond, before the new trend takes hold. Meanwhile, the volume of trades tends to dry up as prices approach the thin end.

Wedges currently abound, among both global equity markets and commodities, like cheeses arrayed on a platter. Take the FTSE as an example. It appeared to enter a rising wedge formation in early June at about 5,250. The index went on to brush short-term highs near 5,600 and 5,700. Meanwhile, in late June, it was tracing out a low at 5,450. (A technical wedge, like a triangle, needs at least five points to qualify).

“It looks like it has bounced off the late spring lows to kiss the higher line a few times, but it can’t get back the gumption to rally over 5,800,” says Mr Gates. “Now it may be ready for the last kiss goodbye.”

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