Looking at the wedge chart pattern, it’s easy to see why it’s so popular with traders. This is because it’s easy to identify, and therefore has a bit “self-fulfilling prophecy” aspect to it. The fact that it also has a simple measuring tool built into it doesn’t hurt either, as it is very simple to use as a tool.
Identifying a wedge
The first thing that we need to do is identify what a wedge actually is. A wedge is simply two trendlines that converge towards an apex. In other words, price is compressing from both selling and buying pressure. It’s like a triangle but doesn’t converge in a horizontal manner. In other words, you may have an uptrend line as per usual, but at the top of trading during the last several candlesticks, the sellers are becoming a bit more aggressive, compressing the market.
To get an idea of what a wedge looks like, take a look at the following chart:On the chart, you can see that the New Zealand dollar has been rising for quite some time, and the red uptrend line shows where there was support on the last move towards the top of the chart. However, you can also see that the sellers were becoming a bit more aggressive, compressing market action on the way up. The highs were getting higher than the ones before but slowing down in terms of momentum. The two red lines show what a wedge looks like.
In this example, it’s what is known as a “rising wedge.” A rising wedge shows compression in and uptrend that signals that there could be something wrong. We are losing some of our momentum, and as a result the highs just aren’t as impressive as they once were. The beauty of this pattern is that a break down below the uptrend line signals that we are going to the bottom of the pattern itself, denoted by the blue line. Beyond that, what’s even more important is that at the very least most traders around the world will see that the trend line had been broken. So even if they are trading wedge patterns, almost all traders pay attention to trendlines. When they get broken, the catch is everybody’s attention.
The stop loss would be placed on the other side of the pattern, and in this case it’s an easy 1:2 risk to reward ratio. By paying attention to the wedge, you are noticing that the market is running out of momentum, and that an eminent reversal may be coming.
Wedges can be bullish as well
Like almost all chart patterns, there is the opposite as well. In that case, you are talking about the “falling wedge.” As you can see on the chart below, the US dollar had been falling against the Canadian dollar quite sharply, and then drifted a bit lower. Notice that the trajectory of the lows weren’t as strong as previous, and then of course the highs were becoming as aggressive as well.As you draw the two trendlines, you can see that a wedge is most certainly forming. Beyond that, we reached the blue line which represents the top of the wedge almost immediately on the breakout. The stop loss would have been on the other side of the wedge, which also would’ve been supported by the hammer that made up the last candle of the wedge before the breakout. If you look forward several days, you can see that the same area offered support on a pullback at least twice.
Yet another way to trade charts
Wedges are simply another tool that you can use to trade your charts. Wedges are fairly common, and also represent trendline breaks, so even if your competitors aren’t paying attention to wedges, they most certainly are paying attention to those trendlines as that is about as basic as it gets. This is why wedge patterns are so potent.