Wedgies, ouch

[Most of this is based on my now 40 year old study of Edwards and Magee.  I haven’t tried to appreciably spruce up my recollection so allow my memory some lapses.]

Edwards and Magee’s (that’s “E&M”, not “S&M”) Technical Analysis of Stock Trends was charting 101 for ‘70s finance students.  As recently as 5 years ago I found it on an ivy league grad school class syllabus.  Written in the late ‘40s early ‘50s, it is often cited as the Bible of TA.  Many painful hand-drawn charts.  It codified Dow Theory and reduced to rules and likelihood the probable trade success of chart formations.  At least, that’s the pigeon hole to which I’ve filed E&M.

Their concepts were rigorously developed in the context of the meaning of primary and secondary trends in Dow Theory.  For example, the head and shoulders was restricted to ending only primary and secondary trends and there was a very well defined and unique pattern of trading volume during the development of the pattern. Today, every newbie (and oldie like me) applies the H&S at the drop of a hat to intraday trading and without regard to volume.  E&M are rolling over in their graves.  But, we often see the short term H&S work.  Maybe the difference is E&M were defining high probability trades where today’s trader is doing just that; trading….or gambling as it may sometimes devolve.

Enter E&M's definition of the wedge.  Upper and lower trend line boundaries that confine price activity.  A wedge is upward sloping in contrast to a triangle.  And the boundaries of a wedge narrow over its life as opposed to the channel.    E&M would say a wedge is a, relatively, short term formation, not one that reverses a primary or secondary trend.  And E&M would say volume decreases over the life of the wedge until it just “peters out” (I do remember that, because, as a 20 year old wannabe something, "peters out" had a giggle factor).  I also remember that when the wedge ends, price falls because there simply aren’t any buyers left.  Price returns to the origin of the wedge in a “fraction” of the time it took to build the wedge.

Like the intraday H&S folks, I’ll depart from the rigorous E&M rules and suggest that there are 2 longer term wedges since the March 2009 bottom.

Note the volume decline over the duration of the proposed wedges.  Note also the time proportions to date; (134 weeks / 113 weeks)^2 = 1.4062.  Sound like sqrt(2)?  And the price proportions if one assumed a final 1922 SPX high (to pull a number out of a rigged hat); (846 / 704)^3 = 1.7354.  Sound like the sqrt(3)?  Not a lot of reason to be much more accurate than the above because E&M’s implications are not much more specific than….. “If volume ends, prices decline to the wedge origin in a fraction of the time.”  [While in quotes, this is from memory.]

The longer volume history was notable (to me at least).  See the bold red lines.

Rise of the day trader to his hay day in 2000.  But we hear the day trader volume since 2000 is way down and somewhat replaced by high frequency trading.  Hard to factor this in, but despite a large portion of volume being HFT, volume continues lower in the last 14 years?  If we had a decline and the day trader were still prevalent, perhaps his/her slow to catch on reaction might mitigate any fall?  Well, what would the now prevalent nanosecond HFT programs do?  Perhaps Flash Crash?

One last thought and this is a stretch (errr, an even bigger one).  What if since the March 2009 bottom two wedges formed a greater wedge?  The first of the smaller wedges (the one that ended on May 2, 2011) did not return to its origin as E&M predicted.  Maybe the real wedge was yet to be fully formed and the decline that marked the end of the first wedge only defined the lower boundary of the larger wedge, now in red.  [Lower boundary from the zero line and upper boundary from the high on that date.]  And the volume over the 5 years?

And maybe pigs will learn to fly.

Jim