Whenever stock market traders talk about falling wedge patterns I am remembered about a young intern I encountered in a job a few years ago. Karan moved to Mumbai rather lanky but in a few months, he became what the elderly lady at reception referred to as "healthy" which was a euphemism for chubby. He always joked (in a raspy horror movie voice) that it was because of the Curse of the Falling Wedges. At a team building lunch someone finally asked him to tell us about the curse. He said that the frozen wedges he bought often got chunked together, and as a result much more wedges than intended fell into his frying pan every night while he was making dinner, resulting in him eating far too much fried potato, resulting in him getting chubby. We lauded him on best excuse for eating too much junk food and ever since I've been reminded of him when I hear about the falling wedge pattern, which is an altogether much more serious topic, admittedly.
A falling wedge pattern, as the name suggests, is one where two trend lines can be drawn across the stock price highs and lows to form a wedge shape.
There are a five typical must-haves for the two trend lines to be referred to as a falling wedge pattern
1 - anything between 10 to 50 days need to line up correctly
2 - the two trend lines must be moving towards a convergence
3 - the angle of the convergence is downward because the stock high price is on a decline
4 - the technical indicator, Volume, which gives traders an idea of market interest, shows a decline
5 - a breakout that occurs specifically above the upper trendline, that is, a sudden movement that is not within the recent trajectory of the trendline.
The falling wedge pattern is a tool used in technical analysis of a stock, that is, it is used to make price predictions based on historical stock price movements. The appearance of a falling wedge pattern heralds a potential price reversal for stock market traders.
Wedge patterns may be rising or falling wedge patterns - in today's podcast we are going to focus on falling wedge patterns. Fun fact - wedge patterns are esteemed as having a better than usual fruition record - in other words, traders say that their price reversal predictions based on falling wedge patterns, become a reality more often than not.
The falling wedge pattern is a bullish pattern. It indicates that demand for stock prices is about to increase, in turn pushing the stock price graph into an upward swing. Just like Karan attributed his weight increase to extra wedges falling into his frying pain, traders predict a price increase from falling wedge patterns on a stock graph.
It must be clearly differentiated from its counterpart, the rising wedge pattern, which is similar in appearance (but the convergence is at an upward angle) and similar in the sense that both patterns signal a price reversal. However the rising wedge pattern - marked by its distinctive upward slopes - is a bearish pattern that heralds a drop in price. As such it is important to be able to tell them apart and to not confuse them.
The falling wedge pattern can be a sign of impending price reversal or can in some cases also indicate a price continuation, but it is always seen as a sign of an impending bullish trend. If the falling wedge pattern appears after a prevailing uptrend, then it is seen as a continuation pattern. Traders thus predict that price increase trajectory from before the falling wedge pattern appeared, will continue. Versus if it appears after a downtrend, wherein it is seen as a reversal pattern. In this case traders expect that the price decrease trajectory, from before and during the falling wedge pattern, will be reversed.
The falling wedge pattern is also referred to as declining wedge or descending wedge. While it is said to have a high rate of panning out as true, traders also say that it is fairly challenging to identify with complete accuracy.
Traders looking to peg their prediction on a falling wedge pattern must recognize this. They must also recognize the fact that even if they were able to definitively spot a falling wedge pattern, and a breakout occurs as expected, they still cannot assume that the impending bullish trend is guaranteed. Other technical indicators must conform the trader's production before he puts his money where his mouth is. It is in fact a good rule of thumb to always consult a handful of technical indicators before making trading decisions.
Irrespective of what the technical indicators convey, traders must also keep tabs on what headlines (if any) are being made but the company whose stock he intends to buy. They charts might show all signs of a price reversal and an impending bullish trend, but if the company makes headlines over something that shakes market confidence, then the opposite could occur in reality.
For amateur traders opting in for expert advice and consultation might also be a good investment to make up for what they might lack in terms of hands-on stock market experience.
They must consider their next move as they would consider any stock market move - acknowledging the potential risk.
All stock market trading decisions must be made with complete consideration and deliberation. Listen to our podcasts and watch our videos so that your consideration and deliberation is well informed.