Analyzing Chart Patterns: The Wedge

Wedges are a multiple price wave reversal pattern. Wedges form when the waves of an asset move within a narrowing range, angled either up or down. Whereas triangles are formed by the price moving sideways, wedges can make significant progress either up or down. 

When the pattern completes, and the price breaks out of wedge, it is usually in the opposite direction the wedge was pointed. This is why it is called a reversal pattern. For example, if a wedge is angled downward—called a "falling wedge"—the price will often break above the top of the pattern and rally. In the case of a wedge angled upwards—a "rising wedge"—the breakout is typically to the downside, indicating lower prices to come. 

Examples of Wedges

Draw a wedge by connecting the multiple swing highs with a trendline, and connect the swing lows with another trendline. During a falling wedge, watch for the price to move above the upper trendline. This is a breakout and completes the pattern. Consider taking a long trade, and shy away from short trades.

For a rising wedge, consider a short trade when the price breaks below the lower trendline. Also consider exiting any long positions.

If trading a rising wedge, place a stop loss just above the most recent high within the wedge. When trading a falling wedge, place a stop loss just below the most recent swing low within the wedge.

Price Target

Wedges can be significant turning points. A breakout may see the price run in the breakout direction for long periods of time. Therefore, isn't a long-term price target for wedge. Rather the pattern gives us analytical insight into where the price is headed, and an entry point into what could be a large move. 

Following a breakout, the price typically moves at least the height of the wedge (measured at the base where the two trendlines start). For example, if the trendlines start at a swing high of $36 and a swing low of $33, the wedge is $3 high at the base. When the price breaks out, expect at least a $3 move in the breakout price. Therefore, in this case, place targets $3 or more away from the entry.

Trading Considerations

Estimate how far the price could run after a breakout by measuring the height of the pattern, but understand that if a major trend is underway, the price could run a lot further. If you are long during a rising wedge, a downside breakout is a warning sign to get out. If short in a falling wedge, and the price breaks upward, consider exiting.

Wedges can last a long time, narrowing into a smaller or smaller price area. This may result in anticipating when then it will end, or taking trades before the breakout thinking that a breakout will occur soon. It is better to wait until the actual breakout occurs than to speculate on when it will happen.