Wedges are a similar to triangles in their appearance. What differentiates them is that the pattern has a definite slope.
Like an arrow head, it either points towards the current trend or against it.
They occur at all time scales but technical traders treat the structures evolving over longer periods as more reliable.
Properties of the Rising Wedge in Forex Charts
In forex the rising wedge pattern hints towards a bearish market.
When the wedge points against the current trend, the probability is on the side of a continuation. However if the wedge is aligning itself with the trend, the probability lies on the side of a market reversal.
To be a useful trading signal, the wedge should be seen to funnel the price into narrow range – though it doesn’t necessarily need to be a point.
As the wedge forms, the price should be making higher highs and higher lows in a saw tooth pattern. See Figure 1.
The bottom line of the wedge should trace a support line that’s upwards sloping. The top of the wedge should trace a resistance line that’s also upward sloping. Note the difference between a rising wedge and an ascending triangle which has a flat top. The latter is a bullish indication.
How to Tell a Reversal from a Continuation
A continuation wedge needs to be a relatively “quick” formation. Like pennants and flags, they are a brief correction of a downward trend. On the other hand the reversal wedge should be a much more significant feature and encompass much of the overall upward trend pattern.
Features of the rising wedge – both types
- It has an upward sloping upper line – resistance
- It has an upward sloping lower line – support
- Lines of the wedge are converging
With a continuation wedge pattern
- The predominant trend must be bearish
- The wedge forms in a correction leg against the trend
With a reversal wedge pattern
- The predominant trend must be bullish
- Main area of trend “funnels” like a pointing arrow
Unlike the triangle, to confirm a rising wedge both the support and the resistance line should have a definite upward slope. This means both the highs and lows in the saw tooth pattern rise.
Reversal wedges are almost always the easier ones to trade.
Shorting the Market on the Rising Wedge
A rising wedge is typically a sign that sellers are gaining the upper hand. In other words, regardless of how it forms, this chart configuration suggests the market is turning bearish.
In both cases you can trade the rising wedge pattern as a bearish breakout. That means selling the currency pair where the pattern is culminating in a point.
We use the same rule when trading the rising wedge as with other triangle patterns. Use the structure itself to judge the likely breakout size and duration.
We measure the depth as the high point of the pattern to the low point. This is used to set the first profit target.
Wait for a clear breakout signal that the lower support has broken. Look for a definite break of the support such as a marker candle. A bearish engulfing candle for example. You can also use our triangle & wedge indicator which auto detects the pattern’s end.
Managing False Breakouts – “Fakeouts”
The breakout, once started, needs to be monitored very closely. Because you’ll normally see the market retesting the upper support lines several times before the breakout shows which side it’s going to move.
False breakouts are very common when trading this chart pattern and can wipe out profits if you’re not careful. There are several ways to lessen the effect. These include waiting for retests or using a split order entry system. See my related post on the descending triangle for more on this.
When the price moves below the lower support lines of the wedge, these lines then become resistance.
If the price rallies up and breaks the first resistance line this is a good time to reduce your position. If you’re using a split order entry method then this is easy to do.
Should the price break the higher resistance line it’s probably safest to quit the trade altogether and wait for a better signal. See Figure 2.
Trading a Rising Wedge in a Reversal
Reversals do offer excellent trading opportunities. They do tend to move very quickly though.
You’ll often see a strong break gather momentum very quickly once the lower support level is breached. This means you have to enter the market early on otherwise most of the move will already have taken place.
The example in Figure 3 shows AUDJPY H4 and a rising wedge that’s hinting at a trend reversal. The whole trend funnels into a pointed cone shape. The yellow line is the 300 period moving average.
As the wedge forms, the up peaks become progressively weaker. A lack of new buyers coming in means the trend is looking vulnerable to a correction.
The start of the breakout is marked with the orange ellipse. This shows the price recoiling back up and retesting the upper level. It’s now looking like a false break. The wedge’s lower support line is now resistance. But there are too few buyers to push up any further.
The price rebounds and the breakout continues downward with increased momentum. The bulls are losing at this stage as the market looks to be moving in one direction only – down.
Nearly one third of the entire move takes place in just over one day. The market then forms a bearish flag – shown as an orange rectangle. We then see heavy selling pushing the price to new lows.
Setting Stops and Profits
In the example above we would set the initial take profit at about 400-450 pips. This is the distance of the wedge from the top tip to the lower tip.
We could set the stop loss to activate if the market moves above the upper yellow line.
The first breakout leg actually moves about 650 pips. The bearish flag raises the odds of a further strong downside break. At this point we could increase the short position. We could also move the stop level and profit levels down.
The new stop loss can be set at the upper line of the bearish flag pattern.
Bearish Continuation Wedges
Though it seems it should be easier, the continuation wedge is in reality the more difficult one to trade.
This is because it’s tricky to identify the end of formation. It’s also virtually impossible to judge how the breakout will unfold.
The example in Figure 4 is a case in point. Here the trend is downwards. The wedge pattern starts to form. But as it ends, the breakout whips upwards and breaks both resistance lines. This false breakout would trigger all but the most aggressive stop losses.
Therefore unless we had wide stops here, the trade would have been in loss. Despite this the strength does return on the sell side and the breakout finally turns bearish.
When you see a rising wedge pattern in a forex chart it is classically a bearish sign. Wedges are very similar to other triangular chart patterns. Rising wedges are a special case in that both edges of the pattern need to have a definite slope in which support and resistance lines are rising and moving together.
The reversal wedge tends to be easier to trade because it develops when an uptrend is about to turn bearish. The continuation wedge usually forms as a brief upward leg in a downward trend.
See the triangle/wedge indicator.