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.
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 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.
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.
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.