The Wedge Formation
Rising wedge formations are created when the following conditions take place:
The stock market (or other markets or individual investments) rises in price. Trend lines drawn that reflect support lines rise at a constant angle.
Trend lines that reflect resistance, where prices turn down, can be drawn at a constant angle as well, but the angle of rise is less than the angle of the support trendline. The result is a converging channel.
Trading volume decreases as the formation develops. This is an important condition because declining volume during uptrends suggests a reduction in buying pressures.
The pattern tells us that although buying pressures are remaining fairly constant, sellers are acting with increasing urgency.
What is actually taking place during the formation of the wedge? Buyers, perhaps to some extent influenced by the rising trendline itself, are buying with consistency and the angle of the supporting trendline remains constant. However, although buying pressures are holding firm, selling pressures are increasing; the descending resistance trendline indicates that selling is coming in earlier in comparison to new buying levels. Sellers are settling for diminishing amounts of profit relative to new buying levels; selling becoming more urgent with each minor market cycle. With net demand and supply relationships weakening, buying and selling pressures converge. The likely resolution is a downside break from the formation.
Please respect the phrase “likely resolution.” Rising wedge formations, which carry bearish implications, usually provide accurate notice that rising price patterns soon will reverse to the downside. Sometimes, however, patterns resolve positively. Positive outcomes are most likely when wedges develop in an area of heavy resistance, a zone in which there has been heavy trading in the past. From time to time, the overhead supply of stocks that creates resistance simply slows but does not permanently impede gains in the market. When the resistance is overcome, stocks burst upward as investors become aware that a bullish breakout is taking place.
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