Stock Trading Strategies > Technical Analysis > Chart Patterns

Rising Wedge Chart Patterns

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