|The rising wedge is a bearish pattern that usually forms as a reaction rally or retracement within a larger downtrend. Typically, the advance will retrace 38-62% of the prior decline. A trendline break signals a continuation lower and projects a move below the low that began the pattern.|
|On the weekly chart, Valero (VLO) formed a lower high in Mar-02 and broke long-term support in Jul-02 (red arrow) to usher in a long-term downtrend. The stock subsequently fell about 50% to around 23 before recovering with a sharp advance back above 35 in Oct-02. In December and January VLO established resistance at 39, a level that also marked a 62% retracement of the prior decline, and later turned into support. Even though VLO exceeded the 62% retracement mark, it never came close to its prior high in Mar-02 (50) and the advance was always viewed as a retracement rally.|
|Figure 1: Weekly chart for VLO|
|Graphic provided by: MetaStock.|
|This advance has since evolved into a rising wedge and the stock broke below the lower trendline earlier this week. With the larger trend down, this support break is viewed as a continuation move that will ultimately result in a decline below the Oct-02 low. There is also support around 23-24, which is confirmed by the horizontal support line extending from Nov-99 and the trendline extending up from Apr-95.|
Figure 2: Daily chart for VLO.
Looking at the daily chart, the stock has clearly broken support with a gap down on high volume (gray arrows). There were two clues to the subsequent breakdown: First, RSI formed a negative divergence over the last few weeks and moved below zero. Second, the price relative (VLO relative to the S&P 500) formed a negative divergence as well and moved below its 50-day EMA. The gap down and break below resistance-turned-support at 39 broke the camel's back and the next support level resides around 32. With a 10% decline in the last few days, the stock could become oversold soon. The trend is clearly down and a rally back to 39-40 would be viewed as a second chance to either exit longs or establish shorts.
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