KLCI prints recurring chart pattern; is third time different?

There is an arsenal of information on chart patterns available to technical analysts. Because they have a strong following among chart readers, a lot of research has been put into the way they are identified and their impact on the market.

There is one triangular pattern called the ‘wedge’. When it appears at market tops or resistance, it often leads to bearish reversals, sometimes sharply. While pattern-based rules tell chart readers how to determine when price moves outside a pattern, it does not state clearly how much price will move. In addition, the outcome is not a certainty as there is room for failure. Still an investor must exercise caution by paying heed when a wedge appear.

Looking at weekly price charts of the Kuala Lumpur Composite Index (KLSE), I have found three wedges going back as far as 1995.

In the first two instances, they appeared when the market topped and were followed by clear reversals. The pattern has appeared. With strong resemblance in terms of market conditions now and then, investors must exercise caution in case this pattern scores a hat trick.

KLCI chart 1

Wedge at market top in 1997 prior to Asian Financial Crisis

KLCI Chart 2

Second wedge at market top in 2008, after credit-induced crisis in US and Europe

How do we know it is going to happen the same way? Pattern-based rules define that the wedge is valid if price closes below the lower boundary (red line in each chart). As I wrote earlier, the outcome is not a certainty. Certainly it makes sense to keep an eye on.

KLCI Chart 3

Latest appearance when key economies in the world are foundering despite rounds of economic stimulus

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