Falling Wedge Approaches Target

05/19/09 09:26:02 AM

by Alan R. Northam

The NASDAQ has broken out of a falling wedge pattern, signaling a trend reversal from down to up and moved higher for almost two months. Will the market continue higher from here, or will a market correction set in? The falling wedge provides the answer...

Security: $COMPQ
Position: N/A

The NASDAQ formed a falling wedge pattern starting in November 2008 and completed in March 2008 when its downsloping upper edge was violated. Since that time, the NASDAQ has been steadily climbing higher over the past seven weeks. According to the Encyclopedia Of Chart Patterns, written by Thomas N. Bulkowski, there is a minimum measurement rule that states that falling wedge pattern should retrace back to the beginning of its pattern. As we can see from Figure 1, the NASDAQ is now approaching the price level of November 2008 where this falling wedge pattern started to develop. This minimum measurement rule also shows that the NASDAQ will have risen 16% from its breakout price to the beginning of the wedge formation. (Note: This article is a continuation of the one I wrote on 04/16/09 entitled "Falling Wedge Signals NASDAQ Reversal.")

FIGURE 1: NASDAQ, WEEKLY. This figure shows the breakout of a falling wedge pattern signaling a trend reversal from down to up. This figure also shows two price levels that the falling wedge predicts that the NASDAQ should move toward. As can be seen, the first price level has almost been reached.

Graphic provided by: StockCharts.com.

The NASDAQ has now risen for seven straight weeks, with each week's trading session forming higher highs and higher lows and each week closing higher than it opened. However, the latest weekly trading bar shows that the NASDAQ opened in the middle of its weekly trading range and closed at approximately the same level. This shows that neither the buyers nor the sellers had control of this market during this week. This is also indicative of a market having reached equilibrium where both buyers and sellers are satisfied with the price.

So where does the market go from here? As long as the NASDAQ remains above its upward-sloping green trendline, this market should continue to move higher. However, overhead resistance lurks ahead by both the round number of 1800 and the reaction high made the first week in November 2008, which also conforms to the beginning of the falling wedge pattern. This area of resistance could turn this market downward for its first official correction since the upward rally off the early March floor began.

Looking past the current price level and the squeeze between the upward sloping trendline and overhead resistance, where is this market most likely to go? Looking at the predictive ability of a falling wedge, Bulkowski's market research shows that on average the market moves 26% higher after a breakout from a falling wedge pattern. This indicates that there is on average the possibility that the NASDAQ could move up to the 1953 price level. However, since a 26% rise from a breakout is an average, it also means that the NASDAQ could fail before reaching 1953 on the price chart, or it could move higher than 1953.

When considering the possibility that the NASDAQ could move higher than 1953, there is one fly in the ointment and that is the open gap just above 1900. Open gaps are typically areas of resistance to a market, and thus, there is a good possibility that the NASDAQ could continue upward after a possible short-term market correction at the 1800 price level to 1900 but beyond that the open gap could turn this market lower in another corrective downward move back to the 1800 price level. Looking beyond 1900 as to where the market goes from there, I think we will need to look at the technicals at that time to determine that answer.

In conclusion, the NASDAQ has broken out of a falling wedge pattern and has moved up to the expected minimum rise in price at 1800. It is possible that this market could now take a break with a downward corrective selloff. Beyond that, there exists a good possibility for this market to continue higher up to the 1900 area before the next correction takes place.

Alan R. Northam

Alan Northam lives in the Dallas, Texas area and as an electronic engineer gave him an analytical mind from which he has developed a thorough knowledge of stock market technical analysis. His abilities to analyze the future direction of the stock market has allowed him to successfully trade of his own portfolio over the last 30 years. Mr. Northam is now retired and trading the stock market full time. You can reach him at inquiry@tradersclassroom.com or by visiting his website at http://www.tradersclassroom.com. You can also follow him on Twitter @TradersClassrm.