Home Business & Management HOW TO IDENTIFY WEDGE PATTERN FOR BETTER INVESTMENT

HOW TO IDENTIFY WEDGE PATTERN FOR BETTER INVESTMENT

A wedge pattern (rising or falling) indicates a pause in the current trend. Wedge patterns signal either continuation or reversal in the market trend depending on the specific market condition.

TOPICS TO COVER

  1. ASCENDING WEDGE PATTERN
  2. Definition
  3. How to recognize
  4. Features and Limitation
  5. How to trade
  6. DESCENDING WEDGE PATTERN
  7. Definition
  8. How to recognize
  9. Features and Limitation
  10. How to trade

ASCENDING WEDGE PATTERN

DEFINITION

Also known as Rising wedge, formed when the price of the security fluctuates between upward sloping Support and Resistance line. The top of the wedge is narrower than the bottom of the wedge as the trading range contracts. Ascending wedge clearly has a bearish bias.

Ascending wedge can indicate both reversal or continuation of market trend depending on the specific market condition when it is form.

If it is formed at the end of an uptrend then it indicates potential trend reversal (Downtrend). If it forms in a downtrend then it indicates the continuation of the downtrend.

Thus, an ascending pattern always generates a sell signal (has a bearish bias). There have some other reversal chart patterns.

Ascending Wedge pattern

HOW TO RECOGNIZE

The rising wedge is a very common chart pattern and occurs (most of the time) in 5 waves (according to the Elliott Wave analysis). It clearly has a bearish bias. Some characteristics to identify Ascending wedge pattern are—–

(a) Prior uptrend:

There should be a prior trend to reverse for the formation of a reversal pattern. A rising wedge typically forms between 3-6 months.

(b) Contraction of the trading range:

The price makes higher high and higher lows. The reaction highs form the upper resistance line and the reaction lows form the lower support line. Both the resistance and the support line are slopping upward. The slopes of the support are more stiffer than the resistance. Hence, as the pattern progresses this causes the contraction of the trading range, creating a cone-like shape pointing upward.

(c) Breakdown of the support line:

Once the price breaks the support line the pattern complete. More aggressive traders take trades at this level and defensive traders wait for further confirmation.

(d) Wait to confirmation until the price goes down under the most recent trough.

(e)  Observe the divergence of price action and volume for further confirmation:

Generally, volumes decline as the price rises and patterns evolve. An increase in volume when price breaks the support line indicates bearish sentiment.

(f) Technical indicators can confirm overbought signal: oscillators, RSI- these indicators can confirm potential oversold signals for further confirmation.

FEATURES AND LIMITATION

1. It is one of the most difficult chart patterns to identify correctly and trade accurately.

2. The loss of upward momentum with each successive high gives the pattern a bearish sentiment.

3. The breaks of the lower support indicates that the sellers are taking control and the forces of supply won. Which indicated lower price are coming.

4. There is no definite technique to predict how much the price of the security will goes down. Others techniques of the technical analysis should be employed to predict the target price.

5. Rising wedge pattern has a relatively low risk and high reward ratio. That’s why it is very popular among professional traders.

rising-wedge-chart pattern

HOW TO TRADE

1. Trading the  Rising Wedge pattern: Method I

After identifying a rising wedge pattern (does not matter where it is in an uptrend or downtrend) enter the market with a sell order (short entry) just below the break out of the lower support line. To avoid faulty breakout and confirmation wait for a candle to close below the support line (wedge pattern).

Place your stop loss just above the upper resistance line (above the wedge pattern).

There is no definite method to calculate the target. But for rough calculation at first measure the height of the back of the wedge pattern. Then extend the height from the entry point to the downward. This price level is your first target.

If the price continues to fall, then make this level your next resistance level.

This method is for aggressive traders.

WEDGE PATTERN

2. Trading the Rising Wedge pattern: Method II

Same as the first method wait for a candle to close under the lower support line. But, place the sell order (short entry) only after the retest of the trend line (support line now becomes the resistance line).

Place the stop loss just above the trend line (newly formed resistance line).

To determine the target, at first calculate the height of the back of the wedge pattern. Then extend the height of the wedge pattern from the entry point towards the downward. This method is for more defensive traders.

ALSO READ: Rising Wedge

DESCENDING WEDGE PATTERN

DEFINITION

Falling-Wedge pattern

The tip of the wedge is narrower than the bass of the wedge as the trading range contracts. Descending wedge clearly has a bullish bias.

The descending wedge can indicate both reversal or continuation of market trend depending on the specific market condition when it is formed.

Also known as Falling wedge, or reverse wedge pattern. They formed when the price of the security fluctuates between downward sloping Support and Resistance line.

If it is formed at the end of a downtrend then it indicates potential trend reversal (uptrend). If it forms in an uptrend then it indicates the continuation of the downtrend. Thus, an ascending pattern always generates a sell signal (has a bearish bias).

HOW TO RECOGNIZE

The falling wedge is a very common chart pattern and occurs (most of the time) in 5 waves (according to the Elliott Wave analysis). It clearly has a bullish bias. Some characteristics to identify Descending wedge pattern are—-

(a) Prior downtrend:

There should be a prior trend to revers for the formation of a reversal pattern. A descending wedge is typically forms between 3-6 moths period of time.

(b) Contraction of the trading range:

The price makes lower highs and lower lows. The reaction highs form the upper resistance line and the reaction lows form the lower support line. Both the resistance and the support line are slopping downward. The slope of the resistance is more stiffer than the support. As the pattern progresses this causes the contraction of the trading range, creating a cone-like shape pointing downward.

(c) Breakdown of the resistance line:

Once the price breaks the resistant line the pattern complete. More aggressive traders take trades at this level and defensive traders wait for further confirmation.

(d) Wait to confirmation until the price goes up and crosses the level of most recent top:

(e)  Observe the divergence of price action and volume for further confirmation:

Generally, volumes advance as the price falls and patterns evolve. An increase in volume when price breaks the resistance line indicate bullish sentiment.

(f) Technical indicators can confirm oversold signal:

oscillators, RSI- these indicators can confirm a potential oversold signals for further confirmation.

falling-wedge-chart pattern

FEATURES AND LIMITATION

1. It is one of the most difficult chart pattern to identify correctly and trade accurately.

2. The loss of downward momentum with each successive lows gives the pattern a bullish sentiment.

3. The breaks of the upper resistance indicates that the buyers are taking control  and the forces of demand won. Which indicated higher price are coming.

4. There is no definite technique to predict how much the price of the security will goes up. Others techniques of the technical analysis should be employed to predict the target price.

5. Falling wedge pattern has a relatively low risk and high reward ratio. That’s why it is very popular among professional traders.

HOW TO TRADE

1. Trading the Falling Wedge pattern: Part I

After identifying a falling wedge pattern (does not matter where it is in an uptrend or downtrend) enter the market with a buy order (long entry) just above the break out of the upper resistance line. To avoid faulty breakout and confirmation wait for a candle to close above the resistance line (of wedge pattern).

Place your stop loss just below the lower support line (below the wedge pattern).

There is no definite method to calculate the target. But for rough calculation at first measure the height of the back of the wedge pattern. Then extend the height from the entry point to the upward. This price level is your first target.

If the price continues to rise, then make this level your next support level.

This method is for aggressive traders.

ALSO READ: Falling Wedge

2. Trading the Falling Wedge pattern: Part II

Same as the first method wait for a candle to close under the lower support line. But, place the sell order (short entry) only after the retest of the trend line (support line now becomes the resistance line).

Place the stop loss just above the trend line (newly formed resistance line).

To determine the target, at first calculate the height of the back of the wedge pattern. Then extend the height of the wedge pattern from the entry point towards the downward. This method is for more defensive traders.

In conclusion, wedge patters forms in real market conditions quite often. Though they do not follow the bookish definition all the time, but they are quite easy to identify.

ALSO READ:

  1. REVERSAL CHART PATTERN
  2. CANDLESTICK CHART PATTERN FOR BETTER INVESTMENT
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