Wedge Pattern

A wedge pattern displays a directional rally resonating between two converging trendlines. If the asset price breaches either trendline, the price action may further extend the post-breakout rally. The wedge pattern may resemble the shape of a symmetrical triangle pattern, as price action narrows its spread as it approaches the peak. However, these patterns are more elongated and influence a particular trend.

What is the Wedge pattern?

This pattern is usually considered a continuation chart pattern as they often appear in existing trends. The wedge formation may follow a countermove, but upon breakout, it signals the continuation of the prevailing trendline.

However, on a large scale, when the pattern itself identifies a significant trend, the resistance trendline breakout may signal a reversal pattern move.

Significance of wedge pattern 

Wedge patterns help market experts understand the upcoming market trends. It predicts the market’s price movement in the short and medium term. Consisting of support and resistance trend lines, the lines in these patterns move in the same direction until one of the two lines breaks. Once any of the two lines are broken, the trend is reversed on a large scale. 

Market analysts use the wedge pattern to show how prices are going to change in the stock market. When the wedge moves higher, there are chances of experiencing a bullish market. Likewise, when the wedges move lower, the chances of experiencing a bearish market go up. 

Investors or traders can use the wedge pattern to know when to put their money in a particular security or asset. They can buy or sell their securities after carefully analysing this pattern. 

There are two types of parallel channel

1. Falling Wedge pattern (also referred to as descending Wedge pattern)
2. Rising Wedge pattern (also referred to as ascending Wedge pattern)

1. Falling Wedge Pattern:

A falling wedge pattern is generally considered bullish as it pushes the security prices upward. It indicates a decline in the selling pressure as the market can shift to a bullish momentum. A falling wedge pattern occurs when the price action moves above the upper trend line. 

Technical analysts believe that falling wedge patterns are highly reliable. As it is a bullish pattern, it is more reliable than the rising wedge pattern. This type is commonly seen during an established uptrend, and the wedge formation would appear facing downward. In theory, this counter trend move offers a short break from the prevailing trendline to stabilize the excessive buying or even indicates profit booking from short-term traders.

A bullish breakout from the resistance trendline may trigger pattern completion and initiate a direction rally.

As shown in the example above, the CRV/USDT pair lowered in a falling wedge pattern from late October to November 2021. Furthermore, the post-breakout rally reached the $5.5 mark(T2), accounting for a 34% rise.

As per the technical setup, the lower highs during the pattern formation act as a viable target, and therefore, it depends on traders’ profit appetite on how long they hold their trade. 

2. Rising Wedge Pattern:

A rising wedge pattern usually happens when a security’s price has been increasing. It can occur during an upward trend or even in a downward trend. The trend lines above and below the price chart come together, and can help traders predict a reversal. Although the price can move above or below either trend line, wedges often break in the opposite direction of the trend lines.

Experts have mentioned that the rising wedge pattern is somewhat similar to a symmetrical triangle pattern. However, the differences between the two lie in their formation, slope, and trend lines. The slope of a rising wedge is definitive while the symmetrical triangle does not have a definitive slope. Likewise, the formation of a symmetrical triangle is mostly horizontal while the wedges form at an angle.

Note: This type is commonly seen during a significant downtrend, and the wedge formation would appear facing upward. Thus, the counter-trend move would absorb excessive selling and or short-trader booking profit. A breakdown from the support trendline may signal pattern completion and set off a downward trend.

The above example shows that from late Feb 2022 to early April, the XRP/USDT pair presented in a rising wedge pattern. The post breakdown fall reached the $0.623 mark(T3), registering a 23.75% drop. Thus, the higher lows during the pattern formation act as a viable target for this type.

How to find a wedge pattern in the live chart?

To identify a wedge pattern in a live chart, investors or traders must look at the four factors mentioned below. 

1. Market trend:

If the market is trending, then only investors can see a wedge pattern. So checking the market movements is necessary as the pattern forms in the middle of the trends. Looking at the longer-term charts can give a better picture of the formation of the wedge pattern. 

2. Presence of necessary reversals:

To depend or rely completely on a wedge pattern, there must be a presence of two necessary reversals. On the price charts, these reversals are represented as peaks and troughs. 

3. Narrowing reversals:

The reversals should come closer or converge when plotted on the price chart. The narrowing of the lines creates a wedge shape. 

4. Declining volume:

A decline in the transaction volume must be noted in the wedge pattern as fewer and fewer traders participate in the trade. 

These four factors determine the volume of transactions, market participation, and the movements in the security or stock markets.

Key features of the wedge pattern

The six key factors determine the characteristics of a wedge pattern. These factors include the following:

1. Converging trend lines:

Converging or closing trend lines are the necessary factor to create a wedge pattern. These lines should move toward each other to form a triangle or wedge shape. These lines link the asset’s prices and how they are moving in the market. 

2. The steepness of trendlines:

The steepness of the trendline is another crucial factor. The slope of the lower trendline is steeper than the upper trendline’s slope in the case of a rising wedge. On the other hand, it reverses for a falling wedge pattern which means the slope for the upper trendline is steeper than the slope for the lower trendline. 

3. Duration:

It takes a longer time to form wedge patterns. These can take between a few weeks to several months to develop properly in the middle of a market trend. 

4. Volume:

The volume must decrease for a wedge pattern. If the volume has not started decreasing, then the pattern might stand invalid. 

5. Breakout:

Watch out for a breakout when identifying a wedge pattern. If the investments are made too early, the chances of bearing losses increase. 

6. Target price:

The best time to gain profits in wedge patterns is before the prices reach the top or bottom of the pattern. 

Trading strategies to follow in a wedge pattern 

The following four strategies can work best for trading in a wedge pattern. 

1. Breakout strategy:

Traders can take short or long positions based on the trendline. They can take the short position when the price breaks below the lower trendline in a rising wedge pattern. 

2. Retracement strategy:

Traders can enter a short position at a better price when the prices retrace back to the lower trendline. 

3. Continuation strategy:

The breakout point can be used to hold a long position and carry out trading in the uptrends. However, it must be noted that the wedges also appear in the uptrend. 

4. Momentum strategy:

The recent price movements of securities decide if they can be bought or sold. It is hoped that the trend will continue in the same direction.  

Difference between a Pennant and a Wedge Pattern

Both the pennant and wedges are a continuation pattern that looks like triangles. However, the major difference between these two patterns lies in their shape and the formation pattern. Pennants are horizontal and sideways while wedges are either ascending or descending. 

Frequently Asked Questions

1: What is a wedge chart pattern?

A wedge chart pattern is a technical analysis formation characterized by converging trendlines that slant either upward or downward.

2:  How does wedge chart pattern differ from other technical patterns?

Wedge chart pattern differs from symmetrical triangles by having either a rising support and resistance line or a falling support and resistance line.

3: How can traders interpret the direction of a breakout in a wedge pattern?

The direction of a breakout from a wedge pattern is crucial for traders. An upward breakout from an ascending wedge may signal a bullish trend continuation. On the other hand, a downward breakout could indicate a potential bearish reversal.

4: Are there variations of wedge patterns, and do they have different implications?

Yes, there are several variations of wedge patterns. Some of the popular ones are the classic ascending wedges, descending wedges and falling wedges.

5: Can wedges be used in combination with other technical indicators for more accurate predictions?

Traders often combine wedge analysis with other technical indicators such as volume, oscillators, or moving averages to back their predictions.

6: Do wedge patterns have a specific timeframe or market preference?
Wedge patterns can be used in various markets, including crypto, stocks, forex, and commodities.