The Dow chart has thrown up several wedge patterns over the past few years at the major highs. This has been a consistent theme – and just this week, there is yet another one on the hourly chart.
A wedge is basically a sloping triangle with the two lines sloping either up or down. When appearing at the end of a long trend, it very often signals a reversal. And that is a tradable event.
Many of these wedges in the Dow have resolved to the downside – usually with a very sharp break. This has enabled me to get on board several short trades early and ride it for hundreds of pips profit.
Remember, these winning short trades were made in an ongoing major bull market. And they appear to give credence to the common advice that you should never trade against the trend.
But I have always had a problem with this advice.
Declines are usually steeper than rallies
My reasoning is this: when you can look at a chart and say ‘this is in a definite up-trend’ it means the trend has attracted a plurality of bulls. There will be a mass of protective sell-stops placed there by these bulls that lie just under the market in a range of prices.
And all it would take is a small dip to set them off – and a large cascading decline would be set in motion. This produces a very quick swing trade profit for those who have established short positions ahead of the break.
These sharp declines often take away gains in hours and days that the bulls have taken days or weeks or months to build up. I like that.
This gives rise to the expression: “Markets climb the stairs slowly, but fall out of the window quickly”. You can see on almost every chart that declines are very often steeper than the rallies.
Not only that, but there is a chance that one particular dip could lead to something much bigger – a large-scale change of trend. And it is these trades that can give you a big trade. But forecasting when one of these dips will turn into a rout – just as is occurring in gold currently – is never easy.
Is the bull market over?
This was the latest wedge I found in my last post of 17 March:
In the above chart, I reckoned a break of the lower wedge line could spell danger for the bulls. After all, previous wedge line breaks have resulted in large down moves.
Let’s update the above chart as it may shed some light on whether the market is poised for a very large leg down:
The short answer is: not yet. Although the market did fall into the danger zone, it did not break it and it has made a series of highly over-lapping waves back towards my lower wedge line. In fact, it has made three kisses on this line, indicating how important the market considers this line of resistance. Isn’t that pretty?
From any of these kisses, a trader could take a short position with the view that the decline off it could be a scalded cat bounce and hence lead to much lower values.
But each time, the market found support and rallied back to the line. The bull market just won’t give up!
MoneyWeek Trader is our FREE spread betting & trading email offering you the very best tips, secrets and guidance from our trading expert, John Burford, who has years of first-hand experience.
To start receiving John's emails three times a week (plus occasional promotions), enter your email address below:
Why I think the Nasdaq bubble is ending
But while the Dow is holding up, the Nasdaq is doing anything but:
The wedge break earlier this month has resulted in only one kiss – a sign of relative weakness compared with the Dow. And my danger zone has been broken with the market currently trading beneath it – unlike in the Dow. This wedge has certainly followed the trend by alerting me to a sharp break.
With the Nasdaq weaker than the Dow, it means that the high-flying tech equities are being abandoned in favour of the more conservative Dow components in a flight from risk. This is a complete turn-around from the picture until recently, where the leaders on the Nasdaq were trading in a parabolic fashion. This is always a sign of ‘irrational exuberance’ (or ‘mania’ or ‘bubble’ as I call it).
As an example, Google is falling to earth. Have a look at the chart!
What a new set of tramlines tells me
So let’s take another look at the Dow chart and see if I can find new tramlines:
Indeed I can. I have lost the upper wedge line but retained the lower wedge line. So that becomes the central tramline now.
From this line, I can draw a solid lower tramline which takes in the three very important low touch points – and also the highest tramline, taking in the highs of the February – March period. I am very happy with this tramline set.
And with these tramlines, I have a new danger zone. If the market can follow the Nasdaq lower and break the lowest tramline and test the danger zone, we may have that elusive sharp break I am looking for. And that would be tradable.• If you’re a new reader, or need a reminder about some of the methods I refer to in my trades, then do have a look at my introductory videos:
• The essentials of tramline trading
• Advanced tramline trading
• An introduction to Elliott wave theory
• Advanced trading with Elliott waves
• Trading with Fibonacci levels
• Trading with 'momentum'
• Putting it all together
• Don't miss my next trading insight. To receive all my spread betting blog posts by email, as soon as I've written them, just sign up here . If you have any queries regarding MoneyWeek Trader, please contact us here. [xyz_lbx_custom_shortcode id=11]