Wedges are often a sign that a trend is running out of steam. A downward sloping wedge indicates that a breakout to the upside is likely, although it is always better to wait for the breakout to occur (and not assume) since the wedge can continue to descend for some time. Once the upside breakout occurs, the stock is likely to attract bullish traders and investors, resulting in at least a short-term rise. Four stocks recently broke out of a downward wedge, or are on the verge, providing an opportunity to pick up shares in these companies with relatively small risk (using a stop loss order) compared to the potential reward.
SEE: Analyzing Chart Patterns: The Wedge
Silver Wheaton (NYSE:SLW) has been in a wedge formation since November, shortly after putting in a 52-week at $41.30. A rally above $37 breaks the wedge pattern and indicates the stock is likely to head higher over the next few weeks to few months. An estimated profit target for the move is $53 to $55. The wedge hasn't completed yet though, so until $37 is penetrated the price could continue to decline within the wedge. If the upside breakout occurs, stops can be placed at $34, below are the recent lows. If a breakout doesn't occur, a drop below $33.25 signals danger and that the stock could decline further.
SEE: The Anatomy Of Trading Breakouts
Best Buy (NYSE:BBY) has a number of wedges underway, mainly because the stock has been in decline for the better part of a year. A small wedge has formed since November, and a sharp breakout higher in January signals the decline may be over ... at least for the short term. The breakout has a target near $17. Ideally the price shouldn't fall back into a wedge, that means support is near $13, but a safer place to place stop is at $12 or $11.50. A drop below $11, is bearish and is likely to result in a further decline.
V.F. Corporation (NYSE:VFC) has been moving in a wedge formation (almost a downward sloping trend channel) since October. After making a 52-week high at $169.82 the stock has been making lower highs and lower lows but that could change soon. VFC is on the verge of an upside breakout. Rallying above $156 is likely to spark buying, pushing the stock towards an estimated target of $168 to $172. Given that the stock is currently in a downtrend, buying should be postponed until after the breakout occurs. A drop back below $145, after a breakout, is bearish (indicating further declines into the $140 region) and therefore the level can be used as a stop.
SEE: Interpreting Support And Resistance Zones
Cepheid (Nasdaq:CPHD) recently broke out of a wedge that began back in June and July. Since the stock has already rallied well off the November low at $28.12 a short-term move lower could occur over the next couple weeks, but support is expected before $32. A drop below $32 indicates the breakout could be false. The target for the breakout is $46 - the current 52-week high. How the stock reacts around that mark will give clues as to the longer term direction of the price.
The Bottom Line
When the price breaks higher out of a downward sloping wedge, it usually indicates there is some upside in store for the stock. Wedges can provide excellent risk/reward ratios for trades since we are assuming a low has been created in the stock, and there is sizable upside to come. No pattern is perfect though, so a stop should be used to help manage risk.
Charts courtesy of stockcharts.com
At the time of writing, Cory Mitchell did not own any shares in any company mentioned in this article.