Originally written: Mon, Jul 28, 2014 at 9:17 AM
Note that this is not a recommendation to buy or sell anything. Risk your money at your own peril.
Summary: SPY is forming a Wedge (which is a bearish signal)
SPY (An S&P 500 tracking ETF) has been rising pretty steadily for more than 5 years now. That’s a big Bull market. As such, I’ve been getting a little nervous about a correction down. But, being a technician, I assume that the trend will continue until it signals conclusively that it is done. At this moment, it has not conclusively signaled, but it is giving a bit of a warning–it has formed a Wedge pattern.
The Wedge: (quoted from Technical Analysis of Stock Trends)
- “a gradual petering out of investment interest. Prices advance, but each new wave is feebler than the last. Finally demand fails entirely and the trend reverses.”
- “the Wedge sets a sort of limit on the advance. Its converging boundary lines focus on a point near where the advance will halt”
- “It can develop either as a sort of topping out pattern of a previously existing uptrend, or …”
- “It normally takes more than 3 weeks to complete.”
- “Prices almost always fluctuate within the Wedge’s confines for at least two-thirds of the distance from the base (beginning of convergence) to the apex; …”
- “Once prices break out … downside, they usually waste little time before declining in earnest. … ordinarily retraces all of the ground gained withing the Wedge itself, sometimes more.”
- “Trading volume tends to diminish”
Our Wedge (marked by the upper Blue line and the Red line) meets all the above criteria. With that in mind, we can expect the Wedge to continue up a little while longer (a week or two), then quickly drop down to at least the first support area (marked by my pink rectangles) and probably also to the second support area. Keep in mind that all of these predictions are statements of probability–it is most likely to occurs as described, but variation is possible. It could breakout downside today. It could breakout a month from now (though that seems very unlikely). It could even breakout upside (though that is the lowest probability outcome–false Wedges are rare).
What to Do:
First, if you don’t own SPY (or a correlated issue like DIA or VOO), don’t buy now. The situation is too precarious. If you do own such an issue (like me) I recommend a fairly close stop, in order that you are tripped out at the beginning of the breakout, but not before. The blue trendline give a fair guide of where the stop should be, with a little lower for some leeway.
At the first conclusive sign of breakout, don’t be afraid to go short for a bit, as those pink boxes provide pretty good price targets.
This market had been confusing me for a while, but reading my old textbook and looking at the chart cleared it up for me.