Understanding Wedge Patterns
In today’s article, we will look at another set of patterns that can be derived from the charts and could be used by the trader to make money from the forex market. This pattern is the wedge pattern.
The wedge pattern should not be confused with any other triangle pattern. In a wedge pattern, both sides of the wedge are convergent and sloping in the same direction, but the angle of slope for one of the trend lines is usually greater than the other. This is in contrast to the ascending and descending triangles where only one trend line slopes, and also contrasts with the symmetrical triangle where both trend lines also slope but not in the same direction.
There are two types of wedge patterns:
– Rising wedge
– Falling wedge
The rising wedge is formed when the two trend lines that connect the highs and lows of the price action slope upwards and converge towards each other, with the lower line sloping more than the upper line. The rising wedge is a bearish pattern.
The chart above shows the rising wedge forming on the chart of the GBPJPY in June 2011. The rising wedge is drawn by connecting at least two points of price lows and price highs, and if the pattern shown in the chart forms, then this is a rising wedge. Being a bearish chart pattern, the trader therefore needs to identify the point of potential bearish price reversal. This could be in the form of a candlestick pattern that supports the bearish move. In this example, a bearish pinbar formed at the upper trend line, confirming the bearish signal.
The falling wedge is formed when two lines that connect the highs and lows of the price action slope downwards, with the upper line forming a greater degree of slope than the lower line. The falling wedge is a bullish pattern.
The chart above shows the falling wedge forming on the chart of the GBPCHF in June 2011. Being a bullish pattern, the trader needs to identify the point of potential bullish price reversal and this could be in the form of a bullish reversal candlestick pattern or could be in the form of a bullish break of the upper trend line as seen in this chart.
Trading the Wedge Patterns
There are two ways of trading the wedge patterns. Wedge patterns can be traded using the conventional breakout strategy, or the trader could trade the wedge range prior to the breakout in the direction of the trade bias.
Trading the Breakout
In trading the breakout, the trader is waiting for a candlestick to close beyond the trend line in the direction of the signal. Using this principle, the trader is therefore waiting for a bullish break of the upper trend line for a falling wedge, or a bearish break of the lower trend line in a rising wedge. The falling wedge example above shows the bullish break of the upper trend line. When the candle in view closes either above the upper line (falling wedge) or below the lower line (rising wedge), the breakout is confirmed and the trader can open a trade position at the open of the next candle, in the direction of the signal. As a rule, bearish breaks last longer than the bullish breaks, and this should be reflected in the trader’s profit targets.
Trading the Wedge Range
What does it mean to trade the wedge range? Since the trend lines serve as price boundaries prior to breakout, it is possible to trade the range of prices within the trend lines. However, it is advocated to trade in the direction of the bias for the trade. Therefore, when trading a falling wedge within its range, enter long at the lower trend line and exit at the upper trend line until the wedge is nearing the point of convergence, then trade the breakout.
The same principle is applied to trading the rising wedge, where the trader should go short at the upper trend line and exit at the lower trend line. As the wedge is nearing the point of trend line convergence, the trader should then switch to the breakout strategy.