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How to Spot a Falling or Ascending Wedge in Forex

   

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Of the many different chart patterns used to predict price behavior for forex currency pairs, wedge patterns are one of the most commonly used patterns.

Wedge patterns are popular for their ease in analyzing on a chart as well as their proven value over time in predicting future price breakouts on the forex market. But while these patterns are easy to identify on a chart, the best practices for trading around them can be a little more complicated and dependent on your overall trading strategy. 

Here’s an overview of how the wedge pattern can be used in your forex trading strategy as well as how to plan trades that minimize risk and maximize potential profit.

What is a wedge pattern?

A wedge pattern is a triangle-shaped chart pattern formed when lines of support and resistance converge. These trend lines are drawn between the high points and low points of a currency pair’s price over a set interval, typically between 10-50 periods. 

Typically, this convergence is viewed as a period of price consolidation likely to produce a breakout in one direction or another. While individual results can always vary from one trade to the next, ascending wedges are more likely predictors of a bearish breakout, while falling wedges have a stronger correlation with a bullish breakout.

In the EUR/USD chart below, a falling wedge develops over a period of roughly 40 days, preceding a breakout that sees the currency pair gain in price for several weeks:

In this graphic, the blue line represents the line of resistance for the price highs, while the orange line marks the line of resistance for price lows.

What are the advantages and disadvantages of using wedge patterns?

As a widely used chart pattern, the wedge can claim a number of important advantages that have won over forex traders over time. But like any pattern or indicator, its limitations must also be understood to stop traders from overrelying on the signals this pattern provides.

Here’s a look at the pros and cons of using the wedge pattern in forex trading:

Advantages

  • The wedge pattern is one of the easiest patterns to identify on a forex chart. Not only is it easy to spot, but it’s also easy to interpret—which gives beginning and expert traders alike a simple analysis tool that offers a clear signal.
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  • Entry and stop-loss levels are easy to define. While some chart patterns can be more imprecise at predicting price movements, a wedge pattern setup typically offers very specific levels where entries should be made, and where a stop-loss should be set to guard against losses. This makes it easy to identify a trade opportunity—including when you can expect price action to occur.
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  • Wedge patterns are widely found on forex charts. Many patterns can offer value in providing signals for traders, but they’re only sporadically seen on forex charts. But as part of your forex trading strategy, wedge patterns can be regularly used to identify breakout opportunities.

Disadvantages

  • Wedge patterns don’t always signal a price reversal. While the wedge pattern does illustrate a consolidation taking place with a currency pair, the setup can often prove false, with price movement continuing in its upward or downward direction after the wedge has been fully created. This is why a stop-loss is so crucial for successful wedge pattern trading.
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  • While wedge patterns are common, identifying them isn’t always cut-and-dried. Wedges can take a number of different shapes, and traders may sometimes feel like they’re forcing a wedge pattern onto a price chart rather than identifying one organically. This can be particularly difficult for less-experienced traders who haven’t developed an eye for identifying these patterns on their own.
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  • Wedge patterns require confirmation from other technical indicators. While this is true of any pattern or indicator, the need for verification is even greater when using wedge patterns due to the high risk of a false signal. 

How can I use wedge patterns in my trading strategy?

The most common way to use wedge patterns is by opening forex positions based on an expected breakout. This can be an effective strategy for targeting profit opportunities that can be timed around the convergence of these lines.

Wedges can also help you determine when you want to close a position. Sometimes this is done to secure profit near the end of an ascending wedge predicted to produce a bearish breakout. But you might also use wedges to cut your losses on a position that didn’t work out the way you intended—and to avoid further losses from the price breakout.

In general, trades taking a longer-term approach to trade analysis will use a longer period of time to identify wedges that support a long position, while traders working on shorter time frames will use shorter price intervals to identify wedge patterns where breakouts are projected to develop on a timeline that suits their trading strategy.

How can I use wedge patterns for swing trading?

One of the most popular—and arguably most effective—ways to use wedge patterns is as a tool for identifying swing trade opportunities. Swing trading is a strategy that looks for dramatic shifts in price movements that traders can capitalize on over a short-term period—typically several days or weeks, but sometimes involving longer or shorter time frames.

Instead of worrying about the long-term value potential of a particular currency pair, swing traders are seeking volatility in price movements. This is where wedge patterns can be particularly valuable. Since a wedge pattern setup may be pointing to a period of consolidation followed by a price reversal, swing traders can use wedge patterns to identify entry points before a price swings in a new direction.

Traders will then attempt to ride the wave of that price reversal as long as they can to maximize their profit. They may use trailing stop-losses to lock in profits as the price increases and price movement continues in a given direction. If you’re interested in swing trading, the wedge pattern may be one of your preferred preliminary tools for identifying potential trade opportunities.

How do I identify falling or ascending wedges?

A great feature of the wedge chart pattern is that it’s easy to identify and monitor—even for new traders just getting used to forex trading. All you need to do is identify the lines of support and resistance and where those two lines meet on the chart.

The high price line will pass through at least two price peaks within the set time frame being evaluated with the wedge pattern. At the same time, the low price line will cross through at least two low points. While a wedge pattern will illustrate both of these lines moving in the same direction, both ascending and falling wedges will gradually converge on each other as the chart develops. 

As a clear wedge pattern develops, traders can then project the point of convergence both in terms of when this period of consolidation will culminate as well as a general price estimate that this wedge is moving toward. In the JPY/EUR chart below, a falling wedge develops quickly and sharply, pointing to a consolidation that results in a quick gain in price:

Trading Tips_ Trading Rising & Falling Wedges on MT4 (Wedge EN)

 

How do I identify falling or ascending wedges?

A great feature of the wedge chart pattern is that it’s easy to identify and monitor—even for new traders just getting used to forex trading. All you need to do is identify the lines of support and resistance and where those two lines meet on the chart.

The high price line will pass through at least two price peaks within the set time frame being evaluated with the wedge pattern. At the same time, the low price line will cross through at least two low points. While a wedge pattern will illustrate both of these lines moving in the same direction, both ascending and falling wedges will gradually converge on each other as the chart develops. 

As a clear wedge pattern develops, traders can then project the point of convergence both in terms of when this period of consolidation will culminate as well as a general price estimate that this wedge is moving toward. In the JPY/EUR chart below, a falling wedge develops quickly and sharply, pointing to a consolidation that results in a quick gain in price:

With this information in hand, traders can estimate not only the direction of a breakout but also the price at which this breakout will occur and when. This can help plan out positions and track the continued development of forex prices to see whether the wedge pattern continues to its point of convergence.

How do I plan trades around a wedge setup?

When you plan to open a position, you should try to time this buy close to the convergence of the lines of support and resistance. Many traders will also target a price at which they are hoping to take profits if the price movement falls in the direction they’re anticipating.

When you plan out your position, you should also plan out an exit point if the price action goes the other way. To protect yourself from suffering steep losses, set a stop-loss that will execute a sell at a modest loss. In the JPY/EUR example above, a stop-loss below the point of convergence would minimize your losses if the price action continued downward, instead of sparking a breakout. 

What are the top indicators to use alongside wedge patterns?

Traders should always validate the signals of a developing wedge pattern through the use of other technical indicators. While you’ll ultimately identify your own preferences in pairing a wedge setup with other indicators, here are a few popular and effective indicators to help you confirm or dispute a wedge setup:

  • Relative strength index (RSI): RSI can help you not only identify overbought or oversold conditions ripe for a price reversal, but it can also help you gauge the strength of a price reversal—and help identify the right time to close your position.
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  • Moving averages: From simple to exponential averages, price reversals may be confirmed when the currency pair price crosses the moving average indicator.
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  • Fibonacci retracement levels: If a wedge pattern is setting up close to a line of resistance or support, it could strengthen the case for a price reversal.
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  • Bollinger Bands: When the price moves outside either of these two bands, a price reversal is more likely to occur.


Once you understand the basic concepts behind the wedge pattern, the next step is to try this out in a live trading environment. Try your hand at executing a forex trading strategy by opening a demo trading account today.

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Disclaimer:

The information provided herein is for general informational and educational purposes only. It is not intended and should not be construed to constitute advice. If such information is acted upon by you then this should be solely at your discretion and Valutrades will not be held accountable in any way.

This post was written by Graeme Watkins

CEO Valutrades Limited, Graeme Watkins is an FX and CFD market veteran with more than 10 years experience. Key roles include management, senior systems and controls, sales, project management and operations. Graeme has help significant roles for both brokerages and technology platforms.

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