Trading Rising and Falling Wedges
Rising and Falling Wedges are one of the most interesting patterns in technical analysis. What distinguishes them from triangle consolidation patterns is that price forms an upward or downward sloping coil that leads to the price move.
Here are two examples of the Rising Wedge Pattern, with the first being an Idealized Representation while the second is a real-world example.
Idealized Pattern:
“Real World” Pattern (with stock name and price removed):
What characterizes the Wedge pattern is the converging slope of both trendlines. The trendlines converge to meet at the Apex, though price is expected to eject out of the pattern prior to reaching the full apex (point at which the trendlines converge).
Classic Technical Analysis states the following:
- Rising Wedges are Bearish Reversal Patterns
- Falling Wedges are Bullish Reversal Patterns
While this is not always the case, it is the classic interpretation of the pattern, which gives a possible pathway (expectation) and yields excellent risk-reward when traded.
How to Trade the Wedge Pattern
For this example, let us assume we have a rising wedge that forms after a lengthy price advance. Let us assume the pattern is a bearish reversal pattern and we are expecting a market top.
A rising wedge needs at least four ‘touches’ or tests of a trendline to confirm the pattern. Remember, a trendline needs at least two points to confirm it as valid. Generally, upon the fourth touch (or test), we would want to be waiting to enter on a breakdown of the lower trendline and place a stop above the upper trendline.
For a more aggressive method of trading rising wedges, you can enter short inside the consolidation inside the 5th swing in price to try for a better execution price. For falling wedges, you would buy on the 5th swing inside the converging trendlines and place a stop beneath the lower trendline.
Most wedges will break-out of the consolidation range anywhere from 66% to 80% of the way to the apex, though some wedges can wait until price reaches the apex for the actual breakout to occur.
For trivia’s sake, the wedge is comparable to an Ending Diagonal (5-wave impulse pattern) in Elliott Wave.
Volume Confirmation
The wedge is a consolidation pattern, and as such, we would expect to see the volume trend decline (reduce) as either the Rising or Falling Wedge pattern develops, and then expand as price breaks outward from the pattern. Your confidence is decreased if we see volume surging during the formation of a suspected wedge.
We would expect volume to increase, or perhaps surge, as price breaks out of the trendline and gathers momentum to the downside (or upside).
I scanned various charts and timeframes to find clean examples of this pattern and it was a difficult task, and from my experience, these patterns aren’t all that common. However, they can be quite powerful if you recognize them developing in real time and act accordingly.
Corey Rosenbloom
Afraid to Trade.com
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Corey,
Good Stuff … What’s your take on current market action holding SPX 820 support and pushing today and hold above SPX 850. This is a headfake rally or do we have longer term breakout getting ready to happen to re-test SPX 950?
Love to hear your comments – Thanks
It was a strong move today indeed. Positive speculation on the bailout and shrugging off the unemployment numbers. That’s bullish. Most people seem to be leaning short so an upmove will nail their stops and create momentum that could easily take us above resistance.
Need to see us break this consolidation but until then we’re trapped and should probably wait for the break instead of jumping the gun.
Rather than wait for the break I have played with a rather active and aggressive strategy for most any decent triangle setup, consolidation, wedges or even just range bound action.
Entering short at the topside once the upper edge is loosely determined, trailing the stop to just above the lower line to allow the price room to test, and make, the break. Reverse for the upside play. If a wedge is likely to break in an expected direction than the position can be entered on the side favouring this bias instead of playing both directions.
Like any strategy there are many drawacks..this one works best with a nicely defined pattern, large swings and a breakout that occurs at about the 75% point, which is probable enough….and low commission rates.
Jeff.
Hi Cory
If you connect all the lows in MS other than the low of Jan, you will get a raising wedge. Can I skip the jan low or does that distort the pattern?
Regards
Jeff,
I’ve been researching the difference between Aggressive and Conservative styles of trade management in terms of entry (early or late), target (big or small), and stop (tight or loose).
You’re right – it comes down to trade-off and compromise, with the best solution probably being what fits your individual psychology/experience/temperament.
Jawed,
I would argue using the Jan 3rd high (or so) to the Jan low then drawing converging trendlines from there makes a better wedge.
If you take it back further, you can form parallel rising trend channels but you’ll need to eliminate the quick swing low in January to connect more points.
Either way, it looks like price has consolidated and is ready for a trend (impulse) move one way or the other. I’d wait for the break to see which way.