When two converging trend lines are drawn such that they connect to their respective lows and highs over the course of ten to fifty periods, this marks the formation of a wedge. Both lines show that the lows or highs are either falling or rising or falling at differing rates. This gives the appearance of a wedge-like shape as the lines approach for convergence. A trendline that is wedge-shaped in its pattern, is considered a useful potential indicator of a potential reversal in a share’s price action.
What is a rising wedge pattern in trading?
A rising wedge , also known as an ascending wedge , is one variety of this convergence. A rising wedge is observed when the price of a security continues to rise over time, or even amidst a downtrend. Here’s what a clear rising or ascending wedge pattern looks like. As shown below, one can see that the lines are slowly coming together as the share’s price remains confined within them.
As shown in the image, rising wedges can be used such that analysts draw trendlines both below and/or above it. As the lines keep converging a trader is able to predict a potential breakout reversal. It is possible that the price may be outside of either trend line, as wedge patterns have the tendency to break in the polar opposite direction from the estimated trendline.
Hence, the core purpose of a rising wedge pattern is to identify and predict falling prices after the price breaks out of the lower trendline. This breakout can be used by traders to make bearish trades. They do so by selling their securities short and using derivatives such as options and futures, depending upon the kind of security that is being charted by them. Hence, the trades would aim to make gains from the falling prices.
Advantages of trading with Wedge Patterns
Patterns like the rising wedge chart pattern appear to be useful when it comes to forecasting the general price trend of a security. Some market studies indicate that a rising wedge chart pattern is likely to experience a breakout of the trendline in the form of a reversal. This means one will see a bearish breakout for a rising wedge and a bullish breakout for a falling wedge. However, the studies also show that more than 65% of the time a falling wedge is a more reliable technical indicator than a rising wedge.
Since any wedge chart pattern – including rising wedge chart patterns – converges to a smaller price channel, the distance between the share price when one enters the trade and the share price for a stop loss is relatively smaller than at the start of the pattern. Both lines are converging so the width of the rising wedge gradually decreases. This means that the risk-preventing stop loss can be placed by a trader around the time the trade is beginning. If the trade is successful, one walks away with a greater amount on return than what they risked at the beginning of the trade.
Identifying a rising wedge in a market
During an uptrend in the market, Identifying the rising wedge pattern is simple. Firstly, during this time, a rising wedge occurs when the two lines are making higher highs and higher lows. A rising wedge can be identified by two lines behaving in that manner that appear to be slowly converging. The share’s price is confined within both of the two slowly rising lines.
Both lines should appear to be getting closer to create a wedge as they converge into each other. This convergence indicates a slowing in uptrend momentum of the share price. This slowing momentum is usually a sign of a potential future reversal to the downside. Hence, use a rising wedge during this time (uptrend) to seek out potential selling opportunities.
Rising wedges can also be identified during a market downtrend. In contrast to a rising wedge pattern in a market uptrend, during a downtrend, one can observe a temporary price movement in the opposite direction. This is known as a market retracement. Similar to the ascending wedge pattern during a market uptrend, this pattern is characterized by shrinking prices that remain within the two lines that are coming together to form a wedge. This pattern indicates a continuation of the market’s downtrend, as momentum slows in the share’s pricing. Traders use the pattern to find selling opportunities before the reversal.