from 3 weeks to 4 months. Durations shorter than 3weeks are probably pennants.The volume trend should be downward. This is not an inviolate rule; it is
only a guideline that usually rings true. For this study, 7 out of every 10 formations show a downward volume pattern.Once prices pierce the upper trendline, they continue higher. Figure 44.2shows prices staging a breakout in mid-June and reaching the ultimate high in
early October. The rise, at 17% from the breakout, is well below the averagerise of 43%.Why do falling wedges act as they do? About two-thirds of the formationsact as consolidations of the prevailing trend. Like the wedge shown in Figure44.2, prices are heading upward when they run into turbulence. Investors
pause from their buying spree and sit on the sidelines. Prices retrace theirgains by creating the wedge, oscillating in ever-narrowing patterns, until thebuying enthusiasm resumes. Volume supports this lack of enthusiasm as itrecedes. When buying momentum resumes, prices and volume shoot upwardagain after the breakout.Think of a falling wedge not as a pattern of weakness, but one of strength.Think of the formation as a spring winding tighter and tighter. As a springtightens, it shrinks, and so too do prices and volume in the falling wedge. During a breakout, the pent-up force releases, and prices burst through the formation boundary and zoom upward.
Mar 95
Figure 44.3 An example of a falling wedge 5% failure. Prices do not move morethan 5% above the breakout point before heading down again.
608
Wedges, Falling
Statistics
609
Table 44.2
General Statistics for Falling WedgesDescription
Statistic
Number of formations in 500 stocks from1991 to 1996
92
Number of formations in 297 stocks from1996 to 1998Reversal or consolidationFailure rate
3377 consolidations, 48 reversals12 or 10%
Failure rate if waited for upside breakout
2 or 2%
Average rise of successful formations
43%
Most likely rise
20% to 30%
Of those succeeding, number meetingor exceeding price target (measure rule)
101 or 88%
Average formation length
1.5 months (44 days)
Jun95
Figure 44.4 Another falling wedge failure. Prices continue down after this downside breakout. Sometimes it is best to wait for the upside breakout before buying.
There are a number of alternating touches of the two trendlines. The volumetrend is irregular but recedes according to the slope of the linear regressionline of volume.In short, the formation passes the various identification guidelines discussed earlier (see Table 44.1). Why, then, do prices breakout downward? Youmight pin the blame on the head-and-shoulders formation that connotes weakness. Of course, if prices moved higher then there would be nothing to say,nothing to blame. I could find no reason to explain this failure and the otherslike it. Fortunately, they are rare and if you play the percentages, it will happen
and they are rare, so you might factor those variables into your trading plan. Isuggest waiting for the breakout before placing a trade.The average rise is a very high 43%. However, the most likely rise isbetween 20% and 30% as shown in Figure 44.5.1 construct the graph by usinga frequency distribution of the percentage gains for successful formations. Ifyou ignore the right column showing gains over 90%, the two highest columns
only once every 10 trades.
StatisticsTable 44.2 shows general statistics for falling wedges. To find enough fallingwedges, I had to search my alternate database too. Together, I only found 125
of these rare chart patterns. Most of them (62%) act as consolidations of theprevailing price trend. This means once the formation completes, pricesresume rising just as they were before the formation began.The failure rate at 10% is quite low and is even better if you wait for an
upside breakout. Then the failure rate drops to 2%. Only 2 out of 125 formations fail to continue higher by more than 5 % before ultimately turning down.Although falling wedge formations seldom fail, they are not easy to identify
Figure 44.5 Frequency distribution of gains for falling wedges. The most likely gainis in the 20% to 30% range but the many gains over 90% pull the average upward.
610
Wedges, Falling
are at 20% and 30%. These two columns have the highest frequency and represent the most likely gain. The chart shows the effect on the average by theoutsized gains (those over 90%); they pull the average up to 43%.I discuss the measure rule at length in the Trading Tactics section of thischapter. Suffice it to say that the measure rule says prices will rise above the topof the wedge, at a minimum. Since meeting this rule does not usually entail alarge price move, prices easily reach the target. Almost all the formations(88%) with upside breakouts have prices that meet or exceed the measure rule(prices rise above the top of the formation).The average length of a falling wedge is about 1 '/2 months. The durationvaries from 20 days to 125 days (about 3 weeks to 4 months).What does a premature breakout look like? Consider Figure 44.6, whichhas both upside and downside premature breakouts. I define a prematurebreakout to be when prices close outside the formation trendline then returnto the formation. During November, for example, prices rise above the toptrendline and stay there for a few weeks. Then prices plunge through the formation and shoot out the other side. The downside premature breakout lastsonly 2 days before returning to the formation. Again, prices move above thetop trendline then sail back below it. Eventually, prices move up and away fromthe top trendline without returning to the formation. This is when the genuinebreakout occurs. Until that point, the other outliers are premature upside ordownside breakouts.
American Express (Financial Services, NYSE, AXP)
Table 4Premature Breakout StatistDescriptionNumber of premature breakouts (up or down)Number of premature upside breakoutsNumber of premature downside breakouts
Premature breakout up, genuine breakout downUpside premature breakout distance to apex
Number showing above average volume on pre
—r—|§
Table 44.3 shows statistics for premtions (27%) experience premature breakside breakouts; the remainder (12%) arehave both types of premature breakouts (What is the likelihood that you will bonly to have the formation break out lowinto this category.Is there a way to tell a premature bremature upside breakouts occur 61 % of thbreakouts happen at the 65% point, on avThe volume trend also offers no cexperience above average volume (usingume) compared with the same percentagemature upside breakouts look just like theTable 44.4 shows genuine breakouoccur 65% of die way to the wedge apex.distance versus the ultimate gain shows t
Table 4
Breakout statistics forDescriptionUpside breakout distance to apexUpside breakoutDownside breakoutUpside breakout but failureThrowbacksAverage time to throwback completionFor successful formations, days to ultimate high|un 94
Jul
Aug
Sep
Oct
Nov
Dec
|an 95
Feb
Mar
Percentage of breakouts occurring near 12-monlow (L), center (C), or high (H)
Figure 44.6 A falling wedge with premature upside and downside breakouts.Premature upside breakouts do not occur very often.
Percentage gain for each 12-month lookback pe
612
Wedges, Falling
Trading Tactics
50% to 80% of the apex distance. This range centers on 65% where the average breakout resides.Upside breakouts occur in 115 formations (92%) and the remainder ofthe formations (8%) have downside ones. Only two formations have an upsidebreakout and fail to continue upward by more than 5 %.Throwbacks for upside breakouts occur 47% of the time. This is a bit toolow to pin an investment strategy on (such as wait for a throwback beforeinvesting). The average time for prices to complete the throwback and returnto the breakout price is 12 days.For successful, upside breakouts, prices reach the ultimate high in 206days, on average. The ultimate high is the highest point reached before anextended (20% or more) downward trend change occurs.Where in the yearly price range do the formations occur? Most (44%)
have breakouts in the lower third of the yearly price range. Mapping the percentage gain onto the yearly price range, we find that those formations withupside breakouts occurring in the lower third of their price range do best, with
a 47% rise. Those with breakouts in the top third have average gains of only36% and so perform worse.This is at odds with the results from other bullish chart patterns. Usually,the best performing formations are those that have breakouts near the yearlyhigh. The momentum players grab hold of the stock and bid it up. With fallingwedges, that is not the case. Why falling wedges behave this way is a mystery.
Perhaps a larger sample size would firm up the results.Only a few statistics (see Table 44.5) relate to the volume of fallingwedges. Most (72%) show a downward volume trend. I determine this by viewing the slope of the linear regression line of volume tabulated over the formation. A receding volume trend is apparent in many of the figures thataccompany this chapter.Table 44.5 shows the breakout volume statistics for the breakout day untila week later. Volume is high on the day of the breakout and trends downward,as you would expect, but it rises the last 2 days. Usually, the volume trend continues moving downward throughout the week after a breakout. This suggestsupside buying momentum increases once investors see the turnaround is athand.
Are low volume breakouts more likely to throw back? No. It is morelikely that high volume breakouts will throw back and the results follow a pattern we have seen in other formations. For falling wedges, the differences areslight, but 40% of the throwbacks occur after a low volume breakout, whereas
42% happen after a high volume breakout. Incidentally, high and low volumeis 150% and 50%, respectively, of the 25-day volume moving average.
Trading TacticsTable 44.6 suggests some trading tactics for falling wedges, beginning with themeasure rule. The measure rule for falling wedges is simple as there is no computation involved. The minimum predicted price is the highest reached in the
formation. Figure 44.7 makes this clear.The highest price is just as the formation starts in early June at 485/8, andit becomes the target price. After the breakout, prices hesitate and attempt athrowback to the formation trendline, but cannot quite reach it. After that, itis straight up. Prices reach the target in early August. The old high is a placeof resistance and it takes about 2 weeks before prices are able to push decidedlyabove that level. Prices move higher until hitting 51 before stumbling and
entering an extended downtrend.Since 90% of the formations result in an upside breakout, there is littleneed to wait for the breakout before buying the stock. However, since pricesare trending down, it is probably to your advantage to wait for the upsidebreakout. By waiting, you might receive a lower price than if you buy earlier,
thereby increasing your chances of success. After a breakout, 98% of all fallingwedges continue rising by more than 5 %. Also, since falling wedges are not theeasiest formations to identify, waiting before buying may allow any identification mistakes to become apparent.If you want to buy the stock but it rises too far before you have a chanceto pull the trigger, you might have another opportunity. Almost half (47%) ofTable 44.6Trading Tactics for Falling WedgesTrading Tactic
Table 44.5
Volume Statistics for Falling WedgesDescription
Statistic
Number showing downward volume trend
90 or 72%
Volume for breakout day and next 5 days compared withday before breakout
138%, 122%, 117%,104%, 106%, 111%
Percentage of low volume breakouts versus high volumebreakouts subject to throwback
40% versus 42%
613
Explanation
Measure rule
Prices should rise to the top of the formation, at a minimum.
Buy after breakout
Since prices are trending down, it is best to wait for theupside breakout before buying.
Buy after throwback
If you miss the breakout and still want the stock, buy after athrowback or add to your position after a throwback onceprices resume rising.
Watch for dip
Twenty-seven percent of formations show a dip just beforethe breakout. This is another reason to wait for the upsidebreakout before buying.
614
Sample Trade
Wedges, FallingArco Chemical Co. (Chemical (Basic), NYSE, RCM)
-42
Apr 94
Sep
Figure 44.7 Measure rule for falling wedges. The highest price in the formationbecomes the target price to which the stock will climb at a minimum.
615
a company entrenches itself with a chamber, it is almost impossible to pry itloose. But Glint has had some success because of the breadth of his offeringsand some skilled marketing ploys.When Glint is not worrying about his business or pitching his wares to aprospective customer, he plays the stock market hoping to make enough extraincome to someday buy out his closest competitor. He recently added multimedia to his demo and that is what alerted him to the company shown in Figure 44.8.From July to September of 1995, the stock made a head-and-shoulderstop pattern. Glint watched the stock stumble, then saw the falling wedge form.He hoped that the new chart pattern marked the limit of the downside moveand that he could buy in at a good price with a mouthwatering chance of pricesrising to the old high.When the stock punched through the bottom wedge trendline, he knewthe wedge was a failure, so he waited to see what prices would do next. He sawthem curl around and make a mini head-and-shoulders bottom and he penciledin a neckline joining the rises between the two shoulders. The neckline followed the slope of the lower wedge trendline.Once prices pushed above the neckline and above the wedge apex, heplaced an order with his broker and received a fill at 30. Glint's timing was
excellent. Two days after he bought, prices were already in the mid-thirties andthe falling wedges experience a throwback. Should this occur in a stock you arefollowing, wait for the throwback to reach the breakout price. Then, prices
Autodesk Inc. (Computer Software & Svcs., NASDAa ADSK)
should turn around and move higher. Wait for the turnaround before buying
as some stocks pause and move horizontally before continuing down.As I was researching this formation, I noticed an interesting quirk. Sometimes just before the breakout, prices drop below the bottom trendline, circlearound, then head up. Figure 44.8 shows an example of this behavior. You can
see in the figure that in early January, prices break out downward, circlearound, then move higher. In late April, prices rise to 441/4, well above thelowof27 3 / 4 .Sometimes the downside breakout takes the form of a premature downside breakout. Prices might drop below the trendline for a few days then reenter the formation only to zoom out the other side and stage an upside breakout.
In either case, the real action is upward. Over a quarter (27%) of all fallingwedges show this momentary downward spin. That is another reason to wait
for the breakout before investing.
Sample TradeGlint is the CEO of a small company that specializes in software for chambersof commerce. It is a cut-throat business because market growth is limited. Theonly way to increase revenue is to take business away from a competitor. Once
Oct9S
Figure 44.8 A failed falling wedge followed by a head-and-shoulders bottom,then a measured move up. More than one-fourth of falling wedges drop belowthe bottom trendline then quickly turn up and head higher. A small head-andshoulders bottom appears as prices swing around the apex.
616
Wedges, Falling
'
45
climbing. He saw prices go horizontal in mid-February through March andwondered if this was the corrective phase of a measured move up formation.That is the way he decided to play it.The base of the measured move was at the head, 273/4, and the top of thecorrective phase was at 38'/2. The height was the difference between the two or10%. Projecting the height upward from the corrective phase bottom of 33'/2gave him a target of 44'/4. He phoned his broker and placed a limit order to sellhis holdings at that price.
Wedges, Rising
When he was out on the road, he took along his laptop so he could dial
into his broker and follow the price action of the stock. The chambers of commerce he dealt with were all on the Internet so getting a connection was never
a problem.In mid-April the stock left the corrective phase and started climbing againon the second leg up. In late April, an e-mail message from his broker told himprices reached his target and the stock sold at 44'/4. In the days that followed,he smiled at his luck. Not only did he hit the high exactly, but the stock tumbled below 30 by the start of July."A few more trades like that and I'll be giving Microsoft a run for theirmoney," he chuckled. "Now, if I could only find a way to keep my wife fromspending it!"
RESULTS SNAPSHOTAppearance
An upward price trend bounded by two intersecting,up-sloping, trendlines
Reversal or consolidation
Short-term (up to 3 months) bearish reversal
Failure rate
24%
Failure rate ifwaited for breakout
6%
Average decline
19%, with most likely decline being 15%
Volume trend
Downward until breakout
Premature breakouts
22%
Fullbacks
53%
Percentage meetingpredicted price target
63%
Surprising findings
The average decline of successful formations withreceding volume trends is 21% versus 15% forupward volume trends. Only 38% of formations havehigh volume downside breakouts.
See also
Pennants
As formations go, the rising wedge is one of the poorer performing chartpatterns. It sports a failure rate of 24%, which falls to 6% if you wait for a617
618
Wedges, Rising
Identification Guidelines
downside breakout. The average decline is 19%, just a bit below the usual20% decline for other bearish chart patterns.One interesting finding concerns the volume trend. Successful formations with a receding volume trend outperform those with a rising volumetrend; the losses are 21% and 15%, respectively. This means if you restrict
your selections to those showing receding volume throughout the formation,you should do better. On the flip side, you will also be passing up many formations in which you could trade profitably.Only 38% of the formations have high volume downside breakouts.Apparently, prices can fall of their own weight even on low volume.
619
During mid-December, prices did not break down out of the of the formation so much as just meander lower. There was high volume on December16, which probably marked the actual breakout, but it only lasted 1 day.Prices attempted a pullback to the lower formation trendline but did notquite make it. Prices moved lower, recovered to post a new high, then withdrew to make another minor low during April. The April low marked thebeginning of a new uptrend that lasted beyond the end of this study in mid1996. By that time, the stock reached 585/s.
Identification GuidelinesTourFigure 45.1 shows an example of a rising wedge. For years, the stock moved ina nearly horizontal trading range between about 25 and 31. The rising wedgechart pattern formed near the bottom of that range. Prices came off the priorhigh, rounded about, and headed up in October.It was not clear from the chart pattern until well into the formation thata rising wedge was forming. The side-to-side oscillations bounded by the two
rising trendlines gave a clue to the outcome. The receding volume trend bolstered the case that the pattern was indeed a rising wedge.Avery Dennison Corp. (Chemical (Specialty), NYSE, AVY)
Rising and falling wedges are among the most difficult formations to identify.However, there are some guidelines that can make identification easier andTable 45.1 lists them.Refer to the rising wedge in Figure 45.2 as I discuss the guidelines. Youprobably first notice the two up-sloping trendlines. Both lines must slopeupward and no near-horizontal trendlines are allowed (a horizontal top trendline indicates an ascending triangle).Prices are moving upward, forming higher highs and higher lows, but two
trendlines bound the price action. Rarely do prices move outside the twotrendlines until the final breakout. However, you sometimes see prematurebreakouts, like that shown in Figure 45.2. A premature breakout is when pricesclose outside either trendline and later return to the formation.You may think that the bottom loop from the breakout point to the pullback is just a premature downside breakout, but prices do not return to closeTable 45.1Identification Characteristics of Rising WedgesCharacteristic
Discussion
Two up-sloping trendlines
Draw two trendlines, one along the minor highs and onealong the minor lows. The trendlines must both slopeupward and eventually intersect.
Multiple touches
Well-formed rising wedges have multiple touches of thetwo trendlines. Be skeptical of wedges having fewer thanfive touches (three on one side and two on the other).
Three-week minimum
A rising wedge has a minimum duration of 3 weeks.Anything less is a pennant. Formations rarely exceed 3 or
Volume trend
Volume usually trends downward throughout theformation.
Breakout volume
Breakout volume can be either heavy or light but isgenerally below average.
4 months long.-23Sep93
Oct
Nov
Dec
Jan 94
Feb
Mai
Apr
May
|un
Figure 45.1 A rising wedge with two up-sloping trendlines. The volume trendusually slopes downward.
620
Wedges, Rising
rising wedge. If there is doubt, do not inveformation. Not trading a wedge until after thcourse of action.Rising wedges can form anywhere. Yoend of a long uptrend and that is indeed thally, prices are heading downward and a risagainst the downward trend. After the breaThe narrowing price action and recedi
Charming Shoppes (Retell (Special Lines), NASDAQ, CHRS)
are signs of weakness. Prices push to new hi
then pull back. On the minor low, weak bu
before it drops below the prior low and turn
The volume trend usually is not exube
the top trendline for long and stage an upsida premature upside breakout (which, intere
Jan 92
jul
Aug
Sep
Figure 45.2 Rising wedge with premature upside breakout. A premature upsidebreakout occurs about twice as often as a downside one.
as often as a downside one), but prices quickdescend out the bottom of the wedge and stThere is still buying demand for the smations descend less than the lowest point ithe patterns that do push lower, they, too, dfrom a rising wedge is just 19%.
inside the formation. Thus, the actual breakout occurs just 3 days after pricesreturn to the formation from the premature upside breakout.
A well-formed rising wedge has multiple touches of the trendline boundaries. Figure 45.2 shows three top touches and three bottom ones (includingthe piercing of the premature and actual breakout points). Fewer than fivetouches, three on one side and two on the other, should cast the formation ina dim light. It might not be a rising wedge at all.A rising wedge with multiple touches takes time to form. Prices make newminor highs and minor lows as they bounce from trendline to trendline. It
takes over 3 weeks for the formation to take on the wedge appearance. Formations shorter than 3 weeks are pennants. On the other hand, rising wedges donot last long. Typically, the apex—where the two trendlines meet—marks theend of the formation. Prices usually break out about two-thirds of the way tothe apex. Rising wedges rarely last more than three months (the longest one inthis study is 145 days—almost 5 months).
The receding volume pattern is another key element in correctly identifying a rising wedge. Most of the time, volume trends downward and becomesespecially low just before the breakout. However, this is not an absolute rule,but the statistics show that formations with receding volume trends performmuch better than those with rising ones.If you are caught in a situation with a rising volume trend but price action
narrows over time, then ignore the volume trend. Review the other guidelines(especially the number of touches) to make sure the chart pattern resembles a
Focus on Failures
With poor measure rule performance andcome as little surprise that rising wedges hformations. Consider Figure 45.3, a 5% fadrop by less than 5% before moving highertypes of failures are rare, occurring only 6%You can see in Figure 45.3 the chart pamove of nearly 2 months' duration. The wdownward price trend. The formation is partmove up chart pattern. Not shown is the first
two up-legs begins in late September, and aThus, one might have reason to susp
work out as expected. Prices move up and toto the other side. Prices cross from side to sing price channel.Prices drop out of the pattern 68% of
you would expect them to. Volume is unu
begins receding the week before the breabefore the downside breakout.Once prices close below the lower trening drive prices down. However, volume is
622
Wedges, Rising
1
Statistics
623
Georgia Pacific Corp. (Paper & Forest Products, NYSE, GP)
Oct 94
Figure 45.3
May 94
An example of a rising wedge 5% failure. Prices fail to move down
by more than 5% before rebounding.
Figure 45.4 A failed rising wedge followed by a long ascending scallop that takesshape from October to February. This is the most prevalent type of failure for rising wedges. Prices break out upward and continue rising.
not have high volume to recede; sometimes they can fall on their own weight.Almost two out of three formations in this study have breakouts with belowaverage volume.If you shorted the stock after the downside breakout, you would have visited the woodshed. No sooner do prices drop out of the formation than they
turn around and head higher. In less than 2 weeks, prices rise above the wedgetop. In another 3 months, prices finally break out of their consolidation zoneand really begin climbing. In July, they reach a new high of over 95.
Figure 45.4 shows a different type of failure: Prices break out upward andcontinue rising. Of the two failure types, this is the most prevalent. The figureshows a well-formed rising wedge. It has many alternating touches of the twotrendlines. Volume is uncharacteristically rising and irregular—a warning sign.
The wedge forms as a sort of consolidation of the upward trend. Although thefigure does not show this, prices start climbing in October 1993 and reach apeak the following January. Then the trend reverses and moves lower executing a long ascending scallop. As prices recover, they form moderately higherhighs and higher lows—a rising wedge.When prices gap (breakaway gap) above the top trendline, it signals theend of the rising wedge. Prices move horizontally for almost 5 months beforejumping upward again.For this failure, as in about 30% of the cases, the volume trend is upward.Certainly the three large volume spikes occurring on days when prices close
higher should be a warning. Still, there is no guarantee that high or rising volume interferes with the performance of a rising wedge.
StatisticsStatistics help define the average formation and can help you gauge what toexpect from a rising wedge. Table 45.2 shows general statistics. Comparedwith falling wedges, rising wedges are plentiful, occurring 179 times in 500stocks over 5 years. A slight majority (54%) of them act as reversals of the prevailing trend.The failure rate is 24%, above the maximum 20% rate that I considerreliable formations to possess. If you wait for a downside breakout beforeinvesting, then the failure rate drops to 6%. The average decline, at 19%, isnear the low end for bearish reversals, which usually score about 20%. Themost likely decline is 15%, shown in Figure 45.5.1 created the graph by doinga frequency distribution of losses. The highest column, at 15%, is the mostlikely decline. If you add the values of the first two columns, you discover thatnearly half (47%) of the rising wedges have declines less than 15%. Such meager declines pose the question, why waste time trading this formation?If we separate the successful formations by volume trend and gauge theirperformance, we discover an interesting result. Those formations with a downward volume trend (as measured by the slope of the linear regression line) perform better than those with an upward volume trend. The performancedifference, at 21% versus 15%, is statistically significant, meaning that theresults are probably not due to chance.
Table 45.2
Statistics
625
Oeneral Statistics tor Rising WedgesDescription
Statistic
Number of formations in 500 stocksfrom 1991 to 1996
179
Reversal or consolidation
82 consolidations, 97 reversals
Failure rate
43 or 24%
Failure rate if waited for downsidebreakout
1 1 or 6%
Average decline of successful formations
19%
Most likely decline
15%
Average decline of formations withdown-sloping volume trend
21%
Average decline of formations withup-sloping volume trend
15%
Of those succeeding, number meetingor exceeding price target (measure rule)
92 or 63%
Average formation length
1 .5 months (44 days)
Downward volume trend
1 32 or 74%
Average volume for breakout day andnext 5 days compared with day beforebreakout
1 31 %, 1 1 3%, 1 07%, 1 1 4%, 1 00%, 1 1 3%
Above average volume breakouts (using25-day moving average)
52 or 38%
In the Trading Tactics section of this chapter I explain the measure rulebut it is quite simple: The lowest price in the formation becomes the targetprice. Even so, only 63% of the formations decline to the start of the wedge(the lowest price). I consider values over 80% to be reliable.The average formation length is 44 days. Rising wedges typically lastfrom 3 weeks to 4 months, so they appear best in daily charts.The volume trend, which turns out to be a good indicator of the reliability of the chart formation, slopes downward 74% of the time. I measured this byfinding