Section 6:
Bearish Continuation Patterns
Bearish Wedge
Definition:
A bearish wedge starts with a sharp downward move over a short period of time. A bearish wedge forms when a stock reaches and repeatedly retests a horizontal support level within the context of a bearish trend.
As the stock bounces up from horizontal support, it repeatedly rolls over at increasingly lower resistance levels. The price action forms a diagonal resistance level, which eventually converges with horizontal support.
Nuance:
The bearish wedge is extremely bearish in nature because the sellers are growing increasingly aggressive over time. This aggressive selling usually overcomes the horizontal support, which generally forms at psychologically or technically significant levels in the stock. A psychologically significant level in a stock might include $20, $50, or $100. Examples of technically significant levels include 52-week lows and multi-year lows.
The bearish wedge can break before the confluence of horizontal support and diagonal resistance. A breakdown before the apex of the wedge is usually an extremely strong signal that the stock is going to trend lower.
Application:
A bearish wedge is confirmed once the stock breaks below horizontal support. Once broken horizontal support is broken, the level can act as resistance on subsequent rallies. Although, in the case of a bearish wedge, a stock usually drops rather precipitously once the pattern is confirmed.
Figure 6.2
Example:
Shares of Office Depot (ODP) traced a bearish wedge with horizontal support at the $18 level as shown in Figure 6.2. Observe how the stock rebounded from the $18 level on several separate occasions. The sellers grew increasingly aggressive, however, pressuring the stock lower and lower. The sellers eventually overpowered the buyers at the $18 level, and the stock plummeted lower.
The ODP bearish wedge was one in which the stock didn’t immediately drop. In fact, ODP hesitated after initially attempting to breakdown from the bearish wedge. The horizontal support at $18 morphed into resistance and capped each brief rally attempt after the stock fell below $18.