One of the most bearish patterns in technical analysis is a rising wedge.
At first glance, this pattern seems bullish because the price of a company's stock or the level of a stock market index generally rises for a while.
However, the end result is normally a move lower - often a major correction.
That's because, in a rising wedge, selling pressure starts to overwhelm buyer demand, resulting in the slope of the upper resistance trend line tilting towards the lower support trend line.
If the support trend line in a rising wedge pattern fails to hold the level of a stock price or a market index and a downward breakout occurs, the resulting price drop may be sharp and significant.
Admittedly, these patterns are generally more meaningful when formed over a short time frame - that is, several weeks.
Nevertheless, I believe the rising wedge patterns that have emerged over the past year in some key stock market sectors and the broader stock market could foreshadow a sharp and deep correction.
Rising wedge patterns have formed in the precious metals sector, the oil patch, financial companies and with broader market indexes such as the S&P 500 Index and the S&P/TSX Composite Index.
Now that we've entered the notoriously most treacherous period of the year, at minimum some caution is warranted, whereas exercising a fairly defensive stance is prudent until the market correction has occurred.
The aftermath should present some interesting buying opportunities that merits keeping some powder dry at this time.
As the market correction unfolds, there are some key support levels to monitor.
For U.S. stocks, key support currently exists for the S&P 500 Index at 2,100, followed by 2,030 and then 1,875.
With regards to Canadian stocks, the S&P/TSX Composite Index may initially find support in the 13,800 to 14,000 range.
Any breach of that range could see support levels at 13,000 and then 12,000 tested.
Precious metals appeared to have bottomed late last year and a powerful bull market has emerged this year. But no bull market is sustainable on a non-stop rise in price.
However, an overdue correction is underway for both gold and silver bullion as well as the precious metals miners.
Gold bullion moved up 30 per cent from December 2015 to August 2016. The correction for gold bullion has been minor so far, but if gold fails to remain at the US$1,300-an-ounce level, then a free fall to US$1,200 could quickly unfold.
For the precious metals miners, the iShares S&P/TSX Global Gold Index ETF (TSX-XGD) is trying to hold support at $15 a unit after almost reaching $18.
A larger correction in the XGD ETF may be in order, perhaps to $12.50 or even $11 a unit. After that kind of a drop, the share prices of the gold mining stocks would become spring-loaded for a massive upward move.
The gold mining stocks that I have profiled over the past year have corrected to some degree along with the precious metals sector. Corrections are normal during a bull market and the precious metals bull market could easily last for five years.
Both Sandstorm Gold Ltd. (TSX-SSL), a gold streaming royalty company, and gold producer Alamos Gold Inc. (TSX-AGI), have more than doubled this year.
Sandstorm's shares have support at $6.50, whereas Alamos' shares should find support at $9 a share in the event that they fail to hold the $10 level.
Meanwhile, I continue to like Alacer Gold Corp. (TSX-ASR). That's because it's well-financed with more than US$300 million in cash and has no debt. Alacer's share price is trying to find support in the $2.90 to $3 range.
The share prices of each of those three gold stocks could be 10-baggers over the next few years as the precious metals bull market unfolds.
Brian Hoffman, CPA, CA, is a member of the Canadian Society of Technical Analysts. Based in Toronto, he can be reached at bk.hoffman@rogers.com.
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