How to trade rising and falling wedge patterns

A wedge is a common type of trading chart pattern that helps to alert traders to a potential reversal or continuation of price direction. Whether the price reverses the prior trend or continues in the same direction depends on the breakout direction from the wedge. Wedges are a useful chart pattern to understand because they are easy to identify, and departures from a previous pattern may present favourable risk/reward trading opportunities.

What are wedge chart patterns?

Wedges occur when the price action contracts, forming a narrower and narrower price range. If trendlines are drawn along the swing highs and the swing lows, and those trendlines converge, then that is a potential wedge.

Wedges can be rising or falling. They can also be angled — for example, where there is a downtrend or uptrend and the price waves within the wedge are getting smaller.

Here’s an example of a falling wedge in an overall uptrend, which uses the Oil & Gas share basket on our Next Generation trading platform.

Wedges can present as both a continuation and a reversal pattern. This means the price may break out of the wedge pattern and continue in the overall trend direction of the asset. However, the price may also break out of a wedge and end a trend, starting a new trend in the opposite direction.

In the chart example above, the falling wedge ended up being a continuation pattern. This is because the overall trend was up to begin with, so when the price broke out of the wedge to the upside, the uptrend continued. In this case, the pullback within the uptrend took on a wedge shape.

Learn more about trading trends and reversals.

What is a rising or ascending wedge?

A rising wedge occurs when the price makes multiple swings to new highs, yet the price waves are getting smaller. Essentially, the price action is moving in an uptrend, but contracting price action shows that the upward momentum is slowing down.

The Cyber Security share basket, which is also available to trade on our platform, provides an example of an ascending wedge. The price action is moving up within the wedge, but the price waves are getting smaller.

When a rising wedge occurs in an uptrend, it shows slowing momentum and may forecast a future drop in price. A drop occurred once the price broke below the rising wedge. However, in this case, the drop was short-lived before another rally occurred.

When a rising wedge occurs in an overall downtrend, it shows that the price is moving higher, (causing a pullback against the downtrend) and these price movements are losing momentum. This indicates that the price may continue to fall lower if it breaks below the wedge pattern.

What is a falling or descending wedge?

A falling wedge occurs when the price makes multiple swings to new swing lows, but the price waves are getting smaller. This creates a downtrend where the price waves to the downside are contracting or converging.

Our USD/CAD chart below provides an example of a falling wedge.

When a falling wedge occurs in an overall downtrend, it signals slowing downside momentum. This may forecast a rally in price if and when the price moves higher, breaking out of the pattern.

When a falling wedge occurs in an overall uptrend, it shows that the price is lowering, (causing a pullback against the uptrend) and price movements are getting smaller. If the price breaks higher out of the pattern, the uptrend may be continuing.

How can wedge patterns be used in combination with divergences?

Wedge patterns are often, but not always, associated with divergence on price-momentum oscillators such as the stochastic oscillator or relative strength index (RSI).

Divergence occurs when the price is moving in one direction, but the oscillator is moving in the other. This tends to occur with wedges because the price is still rising or falling, but with smaller and smaller price waves. The oscillator reflects this by starting to move in the opposite direction as oscillators are measuring price momentum.

A stochastic has been added to the falling wedge in the USD/CAD price chart below. While the price falls, the stochastic oscillator not only fails to reach new lows, but it also shows rising lows for the latter half of the wedge formation. This indicates that downside price momentum is slowing.

The upside breakout in price from the wedge, accompanied by the divergence on the stochastic, helped anticipate the rise in price that followed.

How can I automatically identify rising/falling wedges?

Software can be used to detect rising and falling wedge patterns. For example, our trading platform comes with an automatic built-in chart pattern screener. To find this useful tool on Next Generation, follow the below steps:

Open the trading chart of a financial product of your choosing. This could be a stock, forex pair or commodity, for example. We offer over 10,000 financial instruments to trade on.
Along the bottom of the platform, select the tab “Patterns”.
Then, select the “Wedge” option. The software will automatically draw wedge patterns on the chart, past and present.
Traders can then use these patterns to see how price moved following prior wedges and to spot current wedges that may present trading opportunities.

Since the patterns are drawn based on automated software, use discretion when deciding which wedge patterns to use for trading or analysis.

Detect wedge patterns manually and automatically

How do you trade a rising or falling wedge pattern?

The following is a general trading strategy for wedges and should not be followed dutifully. It can be customised based on how far the trader thinks the price may run (target) following a breakout and how much they wish to risk. Larger stop-losses have a smaller chance of being reached than smaller stop-losses, while larger targets have less of a chance of being reached than smaller targets.

Here are some general strategy steps for trading a wedge pattern.

Identify the wedge on a chart. Draw trendlines along the swing highs and the swing lows to highlight the pattern.
Watch for the breakout. This means the price moves outside the drawn wedge pattern.
Confirm the breakout. Verify that the price has moved outside the wedge. Check the trendlines to make sure that you have drawn them to your liking (typically, they are drawn along, and connecting, swing highs and lows).
Enter the trade. You could open a buy position if the price passes above the upper trendline of a descending wedge, or a sell position when the price falls below the lower trendline of an ascending wedge. Once the price has broken out, it will sometimes come back to retest the old trendline of the wedge. This can provide another entry opportunity.
Set a stop-loss order for the trade. Some traders opt to place their stop-loss just outside the opposite side of the wedge from the breakout. Others may place the stop loss closer to keep the stop-loss size smaller. Risk-management is an important element of trading.
Set a profit target or choose how you will exit a profitable position. An estimated profit target may be the height of the wedge at its thickest part, added to the breakout/entry point.
A trailing stop-loss could also be used. If the price action moves favourably, the stop loss is trailed behind the price to help lock in profit.
Consider the risk/reward ratio before proceeding. After establishing the entry, stop-loss and target, consider the profit potential that the trade offers. Ideally, the potential reward is twice as much as the risk. For example, if the profit target is 1000 points above the entry, as in the chart below, then ideally, the difference between the entry stop-loss (risk) is 500 points or less. If the potential reward is less than the risk, it will be more difficult to make money over many trades, since losses will be bigger than profits.

FAQ

Are wedges a successful strategy?

A trader’s success with wedges will vary depending on their win rate, risk-management controls and risk/reward over many wedge trades. Since there are many potential ways to trade wedges, some may use a trailing stop-loss, small stop-loss, large stop-loss, small profit target or large profit target. It is up to each trader to determine how they will trade the pattern. Learn more about trading patterns.

Can I automatically screen for wedge patterns?

Our web-based trading platform allows traders to automatically scan for wedge patterns using our pattern recognition scanner. However, not all wedges highlighted may be ones you would trade. Use your discretion in assessing whether the price has contracted to form a wedge.

What other chart patterns should I know about?

There is a wide range of trading patterns that you can trade. Simpler patterns include wedges and triangles, whereas more complex patterns include head and shoulders, rounded bottoms and tops, and double and triple tops/bottoms. Read our complete guide to stock chart patterns for more information.

Can wedges be applied to all markets?

Wedges are a common continuation and reversal pattern that tend to occur in many financial markets such as stocks, forex, commodities, indices and treasuries. Sometimes they may occur with great frequency, and at other times the pattern may not be seen for extended periods of time. Browse our range of markets to get started.

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