Wedge patterns are a category of candlestick patterns used in technical analysis to gauge the momentum of price movement in the stock market. Candlestick patterns were first introduced to the western world by Steve Nison as an analytical tool used by Japanese rice traders to predict price movements in the commodity market. These patterns have since gained widespread acceptance among traders in the share market.
A wedge pattern emerges when two lines connecting the successive highs and lows of a security during a trading period tend to converge. The occurrence of these kinds of patterns means that the price range of an asset is getting smaller. There are two main types of wedge patterns — rising wedge patterns, indicating an upward trend in prices and falling wedge patterns, signifying a downward trend in the movement of prices.
Wedge patterns generally form at the top or bottom of a trend. A wedge calls for trading to be done when the straight lines are converging i.e. within the time period of pattern formation. It could take anywhere between a few weeks to 6 months for the completion of a wedge. These patterns have an upward trend line and a downward trend line evolving towards the same point. A major point of departure between wedge patterns and triangle patterns, which too have a pair of trendlines, is that in the former category both the lines are either upward sloping or downward sloping. Whereas only one line is upward/downward sloping in case of triangle patterns.
What is the falling wedge pattern?
The falling wedge, also referred to as the descending wedge pattern, appears when the price of a security constantly touches lower highs and lower lows, thus contracting the range of the price movement. If a falling wedge appears during a downward shift of momentum in the market, it is considered a reversal pattern. This is because the shrinking of the range means that the bearishness with regards to an asset is losing steam.
However, if the descending wedge pattern appears during an upward shift in momentum in the market, then it is assumed to be a bullish pattern. This is because a contraction in the range in this case indicates that the correction in the price of the asset is getting smaller and hence there will be a strong uptrend. As such the falling wedge can appear both as reversal and continuation bullish patterns depending upon the juncture at which it shows up in a trend.
Trading a falling wedge pattern
1. In the best case scenario, the falling wedge will form after a long period of downtrend and signal the final low. It qualifies as a reversal pattern only if there’s a preceding trend
2. At least two intermittent highs are necessary to form the upper resistance line. At least two intermittent low are necessary to form the lower support line
3. The successive highs in the descending wedge pattern should be lower than previous highs and the successive lows should be lower than the previous lows
4. Shallower lows imply that the bears are losing control of the market pressure. As such the lower sell-side momentum results in a lower support line with a slope that’s less steeper than the upper resistance line
5. It is important to take into consideration the volume of trades in a descending wedge pattern, though the same is not true of a rising wedge. Without an increase in volumes, the breakdown will not be well-confirmed.
The falling wedge pattern can be quite difficult to spot and trade in a share market. This tool is generally used to spot a reduction in the momentum of a bear market and signals a potential shift in the opposite direction. However, it is not enough to just wait for a breakdown to start trading — one must also confirm the reversal with other indicators such as RSI, stochastic and oscillator.
It is preferable to start a trade after the price of the security breaches the top trend line. A trader should fix the stop loss at the bottom of the lower trend line. To set out a price target, measure the height of the wedge and extend that length after the breakdown point.