How do you pick stocks to trade? Everyone’s approach for finding trading prospects is a little bit different. And, that’s perfectly fine. We shouldn’t all be chasing the same ideas. If we were, things would get crowded pretty quickly.
There are some bigger-picture premises, however, all of us should be looking for when we’re scouring the market for potential trades. The shape of the current Alibaba (BABA) chart is giving us one of these signals right now.
It’s called a converging wedge, although you may often hear them referred to as pennants. You’ll even hear them called rising or falling pennants, or flags. The idea is the same no matter what you call them though. That is, a chart is being squeezed by falling resistance lines and rising support lines, forcing the stock (or index) in question into the tip of the convergence. Alibaba’s wedge or pennant is plotted with yellow dashed lines on the daily chart below. Yes, there are actually two arguable upper boundaries to this particular pattern.
The stock in question never actually reaches the tip of the wedge, of course. It breaks out its boundaries -- in one direction or the other -- before that happens. But, after enough time spent being squeezed into ever-narrowing confines, that move is usually explosive. It’s also often long-lived.
This shape isn’t the only hint that a major move is brewing though.
It’s not often explained, but stocks (and the market in general) have a funny way of going through major moves, and then stagnating. Sometimes the major moves are bearish. Other times they’re bearish. Sometimes the sideways periods are relatively short-lived. Other times they last a while. Far more often than not, though, one follows the other, which is followed by another, which is followed by another… you get the idea.
We’re seeing this pattern play out with the aforementioned Alibaba. In fact, the key clue that such a cycle is in place happens to coincide with the converging wedge that’s been in place since early last year. The clue? Its moving average lines, from very short-term ones to very long-term ones.
Take a look. After soaring through the end of 2021, BABA stock started a major pullback in early 2022 that stop in earnest until early this year. Now take a close, careful look at all the moving average lines (colored) during this timeframe. They all diverged in 2021, with the short-term ones falling faster than the longer-term ones. As of early this year, however, all four of the key moving averages we watch (20, 50, 100, and 200-day) converged into what’s become a pretty tangled mess. In fact, all four of these lines are now within 5% of one another. That’s pretty unusual.
But what does this mean in practical terms? Simply put, now that these lines are about as converged as they can be, they’re primed to start diverging again. What will cause them to do that? A prolonged, sustained move from Alibaba stock.
The problem is, while we know the spring is coiled here, we don’t know when it finally might start to uncoil. If we’re also watching the lines that make of the converging wedge pattern above, though, we’ve got a much better idea of when that move is finally underway.
Not every chart will make this shape and drop these hints every time, of course. In fact, some stocks are never this generous with their “tells.” There’s also no guarantee these clues will pan out the same every time, or as implied. There’s always some element of risk – including the risk of the unknown -- in trading. These are just tools meant to help you improve your odds of success with a particular trade. You may want to use them in conjunction with other tools and indicators.
No matter how you find your trades though, these subtle trading clues are too good to ignore.