Declining Wedge in the S&P 500
This is a chart of the S&P Futures (ES!) showing a declining wedge pattern. While technical analysis is admittedly down on the list of my personal trading hierarchy, I think this particular formation is presenting some interesting implications and possible trade ideas.
Macro factors not withstanding, I wouldn't be surprised to see either A) more channeling between the 4150 - 4400 range, or B) a relief rally north of 4500 over the next month or two. The Declining Wedge idea supports this thesis...
The statistics indicate that Declining Wedges are not a great performer compared to other patterns - and that's ok, because these trade ideas don't need them to be. If we temper expectations and use defined risk, a modest snap to the upside can offer some nice profitable trades. I like to use the "Encyclopedia of Chart Patterns" by Thomas Bulkowski to give my technical analysis some statistical grounding. According to his research, in the context of a bear market (which we seem to be in, at least in the short term), a Declining Wedge has about a 75% probability of making a 5% reversal move, and about a 68% probability of moving 10%. The S&P also currently meets the identification guidelines of a minimum of 5 trend line touches and declining volume (as depicted in the chart). Also note that the Wedge is occurring near the edge of the value area on the Volume Profile. So how to trade it?
Since the Declining Wedge isn't a particularly strong pattern, I'd recommend using a defined risk strategy like a vertical spread. Unfortunately due to the current elevated level of implied volatility, vertical CALL spreads aren't pricing particularly well - but here's one:
Buy SPY 435 18 APRIL 22 CALL
Sell SPY 437 18 APRIL 22 CALL ... this was pricing around a -0.78 Debit... its not a great risk reward, but its viable and fits within the thesis - but what if we dig deeper?
Consider for a moment that on a Year To Date basis, the Nasdaq is lagging the S&P. The NQ is rallying considerably this morning, but before the open, it was down by about -14% YTD vs. -11% on the ES. So perhaps if the market bounces over the next month, it will be propelled by mean reversion in the NQ. The NQ is suffering from the same problem as the ES so from a risk reward standpoint, the spread I'd build in the QQQ would follow the same logic as the trade in SPY above - you just might get a little more upside movement in the NQ and thus a little more bang for your buck - maybe... but here's an interesting idea...
Can you think of a Nasdaq stock thats been nearly cut in half since the start of the year? Because I can - Facebook. Regardless of the Declining Wedge idea, FB will likely have a vicious relief rally in the coming weeks, if for no other reason than the eventual short covering. I'm very interested in putting on a ratio back spread in FB in anticipation of that move. Something like this:
SELL -1 FB 29 APR 22 CALL
BUY +2 FB 29 APR 22 CALL ... this was pricing for around a +0.27 credit ...
Bear in mind there is a significant amount of risk in this trade with a max loss of about $1,500 per unit. However, the exepected move for FB over the next 45 days is about +/- 30pts, which gives this trade fairly good odds of seeing degrees of profitability over that time - and bear in mind that the profit potential is pretty damn good considering the trade is being done for a credit.
Happy trading :)
Macro factors not withstanding, I wouldn't be surprised to see either A) more channeling between the 4150 - 4400 range, or B) a relief rally north of 4500 over the next month or two. The Declining Wedge idea supports this thesis...
The statistics indicate that Declining Wedges are not a great performer compared to other patterns - and that's ok, because these trade ideas don't need them to be. If we temper expectations and use defined risk, a modest snap to the upside can offer some nice profitable trades. I like to use the "Encyclopedia of Chart Patterns" by Thomas Bulkowski to give my technical analysis some statistical grounding. According to his research, in the context of a bear market (which we seem to be in, at least in the short term), a Declining Wedge has about a 75% probability of making a 5% reversal move, and about a 68% probability of moving 10%. The S&P also currently meets the identification guidelines of a minimum of 5 trend line touches and declining volume (as depicted in the chart). Also note that the Wedge is occurring near the edge of the value area on the Volume Profile. So how to trade it?
Since the Declining Wedge isn't a particularly strong pattern, I'd recommend using a defined risk strategy like a vertical spread. Unfortunately due to the current elevated level of implied volatility, vertical CALL spreads aren't pricing particularly well - but here's one:
Buy SPY 435 18 APRIL 22 CALL
Sell SPY 437 18 APRIL 22 CALL ... this was pricing around a -0.78 Debit... its not a great risk reward, but its viable and fits within the thesis - but what if we dig deeper?
Consider for a moment that on a Year To Date basis, the Nasdaq is lagging the S&P. The NQ is rallying considerably this morning, but before the open, it was down by about -14% YTD vs. -11% on the ES. So perhaps if the market bounces over the next month, it will be propelled by mean reversion in the NQ. The NQ is suffering from the same problem as the ES so from a risk reward standpoint, the spread I'd build in the QQQ would follow the same logic as the trade in SPY above - you just might get a little more upside movement in the NQ and thus a little more bang for your buck - maybe... but here's an interesting idea...
Can you think of a Nasdaq stock thats been nearly cut in half since the start of the year? Because I can - Facebook. Regardless of the Declining Wedge idea, FB will likely have a vicious relief rally in the coming weeks, if for no other reason than the eventual short covering. I'm very interested in putting on a ratio back spread in FB in anticipation of that move. Something like this:
SELL -1 FB 29 APR 22 CALL
BUY +2 FB 29 APR 22 CALL ... this was pricing for around a +0.27 credit ...
Bear in mind there is a significant amount of risk in this trade with a max loss of about $1,500 per unit. However, the exepected move for FB over the next 45 days is about +/- 30pts, which gives this trade fairly good odds of seeing degrees of profitability over that time - and bear in mind that the profit potential is pretty damn good considering the trade is being done for a credit.
Happy trading :)
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