Wedge Pattern Explained

The wedge pattern is one of the reversal patterns that appear on a price chart and point to a change in trend. What stands out about this pattern is how easy it is to spot, which makes trading it more straightforward — though, like any chart pattern, its signals can fail. In this article we explain both types of wedge pattern and how each of them can be traded.

What is the wedge pattern?

It is a reversal pattern that signals a change in trend, and it comes in two types:

• Falling wedge: a technical pattern that appears on the chart at the end of an uptrend; price moves inside the pattern in a narrow range with a limited upward slope.
• Rising wedge: a technical pattern that appears on the chart at the end of a downtrend; price moves inside the pattern in a narrow range with a limited downward slope.

Read also: Double Top Pattern Explained

Characteristics of the wedge pattern

• The first thing to know about wedges is that they often hint at a trend reversal, or at least a deep correction.
• The longer the pattern takes to form, the stronger the resulting breakout tends to be.
• Price movement inside the pattern narrows as the pattern develops, until it is squeezed at the tip.
• The pattern’s boundaries act as support and resistance lines, since price bounces whenever it reaches either edge of the pattern.

The chart below shows a rising wedge pattern.

Notice how the rising wedge forms when the market starts making higher highs and higher lows. All the highs should line up so they can be connected with a trend line, and the same applies to the lows. A rising wedge is not valid unless the highs are connected by one trend line and the lows are connected by another.

The same thing happens with the falling wedge, only in the opposite direction. The falling wedge pattern occurs when price starts forming lower lows and lower highs, which are then connected by trend lines.

The chart below shows a falling wedge pattern.

How to trade the wedge pattern

Technical patterns are generally traded when a breakout of one of their boundaries occurs, and the wedge — being one of those technical patterns — is no different. Once the upper or lower boundary of the wedge is broken, opening a trade can be considered.

Look at the following chart.

In the chart above, we waited for the market to close below the support level. A sell trade could have been opened at that moment, but the better option is to wait for a retest.

Why the retest?

Because waiting for the retest gives you a better risk ratio than entering immediately after the break.

The same applies to the falling wedge. This time we wait for the market to close above resistance, then wait for a retest of the level as new support.

Setting the stop-loss order

Now that we know how to identify the pattern and how to enter a trade, we come to the most important part: setting the stop-loss order.

Finding a suitable place for the stop loss is a little harder than picking the entry point, because every pattern has characteristics that differ from other patterns.

Even so, the rule stays the same: we always place the stop-loss order in an area where, if price reaches it, the pattern is considered to have failed.

Let’s look at the most common stop-loss placements when trading wedges. Below is a close-up of a rising wedge after the breakout.

Notice how the stop loss was placed above the last high of the pattern. If our stop loss is hit at that level, it means the market has reached a new high, so trades based on the wedge pattern can no longer be maintained.

Once again, in the chart above the stop loss was placed strategically. If price reaches the stop-loss level shown, it means a new low may have formed, which would invalidate the trade based on the wedge pattern.

If a fast move at the retest produces a candle with a long tail and a small body, we can place the stop loss beyond the candle’s tail, as shown in the example below.

In the chart above, a bearish candle formed after the retest of the previous support. We can use it to set the stop-loss order.

Whatever strategy you use, remember to always place the stop-loss order at a level that would indicate the current pattern has failed.

Setting the take-profit order

Now we come to the enjoyable part: taking profit. Support and resistance areas are easy to identify in both the rising and the falling wedge, because the pattern itself forms as a ladder of highs and lows. Let’s look at the rising wedge first.

Notice how we use the lows to identify support areas. These levels provide an excellent starting point for mapping potential short-term take-profit zones.

Of course, we can use the same concept with the falling wedge.

Read also: The three best forms of the triangle pattern on a chart

Conclusion

• The pattern’s characteristics are:
  • The pattern often hints at a trend reversal, or at least a deep correction.
  • The longer the pattern takes to form, the stronger the resulting breakout tends to be.
  • Price movement inside the pattern narrows as the pattern develops, until it is squeezed at the tip.
  • The pattern’s boundaries act as support and resistance lines, since price bounces whenever it reaches either edge of the pattern.
• The rising wedge forms when the market starts making higher highs and higher lows. All the highs should line up so they can be connected with a trend line, and the same applies to the lows. A rising wedge is not valid unless the highs are connected by one trend line and the lows are connected by another.
• Technical patterns are generally traded when a breakout of one of their boundaries occurs, and the wedge pattern is no different. Once the upper or lower boundary of the wedge is broken, opening a trade can be considered.
• Whatever strategy you use, remember to always place the stop-loss order at a level that would indicate the current pattern has failed.

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• Elliott Wave Corrective Patterns