Trading What I See

The end of a move will usually show a marked decrease in momentum, and this will often show up as either a WEDGE or a DIVERGENCE. Either is a warning that the trend may be ending. Today was full of wedges.

Wedges are more reliable when preceded by a strong directional move, but they should never be ignored. Whether or not you use them for an actual trade depends on the particular situation.

Today’s first wedge (yellow letter A) seems to have at least temporarily ended the decline that started last Thursday. A wedge has a target — they will normally retrace the entire height of the pattern, and often do so in a single thrust. Today’s retracement took two thrusts to hit target, which could have been a warning that we were turning sideways rather than actually reversing. It also created another wedge.

One nice thing about wedges. You don’t have to do anything special to have them show up on your charts except draw the regular trendlines. If the upper and lower trendlines start to converge, you have a wedge. Edwards and Magee, in Technical Analysis of Stock Trends [see my review], warn against trading inside of convergent trendlines, since your opportunities for profit become smaller and smaller as the lines get closer together.

Today’s market gives a good example, particularly in the magenta wedge labeled “B.” The second thrust falls well short of a 100% Measured Move, and to me that indicates either a potential reversal or a sideways pattern. Since there wasn’t a “move” to reverse, sideways was not surprising.

I became cautious at the bottom this morning because of the converging trendlines, but since there was no divergence I didn’t enter a reversal trade. By the time we finished the second thrust of wedge “B” I was guessing the day would end sideways, and split my time between paperwork and watching the market.

There were several potential Fibonacci and trendline entries during the day, but they happened during times of flat moving averages or the trendlines were converging again. In either case I tend to pass.

Wedges are useful, and I like to trade them when everything lines up. But today they just served to keep me from wasting money.

Edwards and Magee’s Technical Analysis of Stock Trends