A Guide for Trading Rising and Falling Wedges
A wedge falls into the same category as the head and shoulders pattern: it is a reversal pattern. It means it is forming either at the end of a bullish trend or at the end of a bearish one. A wedge that forms at the end of a bullish trend it is being called a rising wedge. This is because its head is rising, or the overall price action within the wedge pattern is a bullish one. On the other hand, a wedge that forms at the end of a bearish trend is called a falling wedge. As a rule of thumb, a rising wedge is a bearish reversal pattern, while a falling wedge is a bullish pattern. Wedges are forming more often than head and shoulders, but this doesn’t mean they are not effective. As a matter of fact, if I were to compare the two reversal patterns, I would value a wedge more than a head and shoulders pattern. This is because it takes less time to form and because they can form even if there’s no previous strong trend before the pattern. More on this a bit later in this educational article.
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What Makes a Wedge?
The image below shows the typical wedge and how such a pattern is looking like. After a bullish trend, the price is making marginal highs only for the market to aggressively move lower after the wedge is broken. The same is valid after a bearish trend: the market is moving higher after the wedge is broken and, in a way, the wedge resembles a triangular formation. The only difference between a wedge and a triangle is the fact that a triangle is usually forming on the horizontal, while the wedge is not. It is being said that a rising wedge is falling and a falling wedge is rising, and this tells much about the price action to be expected after such patterns form. Trading a wedge is straightforward and leaves room for little interpretation, as it can be seen below.
Wedges with Elliott Waves Theory
The most representative part of the Forex Trading Academy project is the one dedicated to the Elliott Waves theory. Under this theory, the market is moving in corrective and impulsive waves, and counting waves is the base of it. Moreover, impulsive waves are labeled with numbers and corrective waves are labeled with letters. Even though a wedge is having all its segments as corrective waves, it should be labeled with numbers. Elliotticians are associating a wedge with an impulsive wave, but not a regular or a classical one, but a terminal one. Such an impulsive wave is always completely retraced, and it is having no more, no less than five segments. That is five waves.
The chart above shows the EURUSD weekly time frame and a beautiful rising wedge pattern forming there. As the name suggests, the pattern should be a bearish one, as it can be seen by the price action that follows.
Based on the Elliott Waves theory, the wedge should be labeled with numbers, even though all the waves are corrective in nature. Any wedge is having a five waves structure.
The chart above shows the five waves structure of the rising wedge and Elliott Waves traders are looking for the 1-3 trend line to be broken. Any wedge is traveling between the 1-3 and the 2-4 trend lines and the general assumption is that the 1-3 trend line is mandatory to be pierced. While this is happening in this case, it should be noted that it is not something that should be viewed as a rule. There are wedges that don’t pierce the 1-3 trend line as the most important line is the 2-4 one. This means that all the focus should be on drawing the 2-4 trend line and watch for the break of it. Such a break implies the whole pattern is completed and the market started the next wave.
Retesting the 2-4 Trend Line
Usually, the 2-4 trend line is being retested after its break, but this is not mandatory. The example above shows the EURUSD not doing that, and trading for the 2-4 trend line to be retested will result in great losses. As a rule, traders should only look for the wedges to break higher/lower, depending on their nature, and that should be enough to mark the end of the previous trend. If the wedge is forming at the top or bottom of a trend, the break lower/higher should be significant. However, if the wedge is not forming at the top/bottom of a trend, it means a triangular formation just ends. The break lower/higher should be even more powerful, especially if the wedge is forming on the bigger time frames.
Other educational materials
- How to Use Parabolic SAR to Buy Dips or Sell Spikes
- Bollinger Bands – Profit from One of the Best Trend Indicators
- How to Draw a Trendline
- Forex Market Terminology
- Profit from Forex Trading Using Different Trading Styles
- Pennants as Continuation Patterns
Recommended further readings
- “Trade policy and economic growth: a skeptic’s guide to the cross-national evidence.” Rodriguez, Francisco, and Dani Rodrik. In NBER Macroeconomics Annual 2000, Volume 15, pp. 261-338. MIT Press, 2001.
- “Can comparative advantage explain the growth of US trade?.” Cuñat, Alejandro, and Marco Maffezzoli. The Economic Journal 117, no. 520 (2007): 583-602.