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Wednesday, May 15, 2013

Wedge chart patterns



I want to start a series of articles on various technical chart patterns. I do believe that if you learn them and start applying in your trading you will significantly increase your chances of making stable money in financial markets. I have recently finished one series on different market conditions: calm trend, calm range, volatile trend and volatile range and I would suggest that you read those very carefully at least once. You should find a lot of useful practical tips in each article. Now, this article will cover a pretty power technical pattern: wedge. I like trading this one as we usually have a very powerful breakout out of the pattern and prices move very strongly and fast when a wedge is broken. So, let us analyze what this pattern is and how you can successfully trade it. 

What is a wedge? It is a technical pattern with a narrowing range within two converging trendlines (that slant in upward or downward direction (depending on the type of a pattern: upward or downward)) and that usually indicates an end of a trend that can be traced in the pattern itself. It means that if you have a falling wedge (prices are going down) the breakout will most probably be upwards. Price moves between the two trendlines and the narrowing range builds pressure for an upcoming breakout. If you have a rising wedge (prices are going down) the breakout will most probably be upwards. Well, maybe the explanation was kind of difficult, but when you see the examples you will clearly understand what the pattern is like. 

When you finish reading the post I recommend reading other related posts and watch a video below:
Falling wedge

Falling wedge is recognized as a bullish technical chart pattern. You can clearly see converging trendlines in the pattern that has a downward direction. The range is narrowing towards the end of the pattern and most often than not prices break upwards starting a new trend or continuing a previous one. 

The example above in usd/jpy pair clearly shows us a nice falling wedge pattern. As the price was moving down and the range of the wedge narrowing increasing pressure and finally causing the pattern to be broken upwards with an explosive move. The pair moved around 600 pips when the upper trendline of the wedge was broken. That is precisely what you are looking for. You expect the upper trendline to be broken in a wedge. If it is not, the pattern is finally distorted and loses its’ validity. 

How to trade the pattern?

You need to place a buy stop order above the closest point where the price hit the upper trendline and then retraced. If it failed to reach the lowest low (of the pattern) you place the stop loss a few pips below the retracement (from the upper trendline). In the example above you can see that the point for entry in usd/jpy was 93.68 level (a few pips above that) since that was the place where the price hit upper trendline and retraced. The price however failed to reach previous low and started rising again. The lowest point of retracement marked a level where we need to place our stop loss order. In our case that would be 92.71 level (a few pips below that). Open your chart to find out yourself entry and stop levels for the trade. You either exit your trades by moving stop loss as the price moves in the direction of the trend till the stop is hit or you exit your trade at a predefined level. In the latter case you still need to move your stop in order to protect your profits. 

Rising formation

Falling wedge is recognized as a bearish technical chart pattern. You can clearly see converging trendlines in the pattern that has an upward direction. The range is narrowing towards the end of the pattern and most often than not prices break downwards starting a new trend or continuing a previous one. 

The example above in eur/usd pair shows an excellent rising wedge pattern. As the price was moving up and the range of the wedge narrowing increasing pressure and finally causing the pattern to be broken downwards with an explosive move. The pair moved around 900 pips (with minor retracements) when the lower trendline of the wedge was broken. That is precisely what you are looking for. You expect the lower trendline to be broken in a wedge. If it is not, the pattern is finally distorted and loses its’ validity. 

How to trade it?

You need to place a sell stop order below the closest point where the price hit the lower trendline and then retraced. If it failed to reach the highest high (of the pattern) you place the stop loss a few pips above the retracement (from the lower trendline). In the example above you can see that the point for entry in eur/usd was 1.3203 level (a few pips below that) since that was the place where the price hit lower trendline and retraced. The price however failed to reach previous high and started falling again. The highest point of retracement marked a level where we need to place our stop loss order. In our case that would be 1.3243 level (a few pips above that). Again, you either exit your trades by moving stop loss as the price moves in the direction of the trend till the stop is hit or you exit your trade at a predefined level. In the latter case you still need to move your stop in order to protect your profits. As you may see your stop loss was only 45 pips and the potential profit very big (900 pips). So, when you see a wedge forming next time get ready to take a trade.

Time frames

Some say that the pattern has to be three or six months in length and I could not agree less. You will notice those patterns on various time frames. If it is a continuation pattern and a wedge is formed in a counter trend move you would usually see it on hourly chart and that may last a few days. And then you have a nice breakout in the direction of the prevailing trend. On a longer term chart (lasting months and weeks) the pattern will probably signal a reversal and a change of trend. 

Ok, I will finish now. Be sure to read related articles to learn more on technical analysis. I promise to expand on this in my future posts. 

I hope you benefited from the post. If you liked the post I would also be happy if you gave a plus on Google+, tweeted, liked it on Facebook and other social platforms. Have a nice day. 

Vytas.


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Disclaimer
Trading financial markets carries a high level of risk, and may not be suitable for all investors. All information on the blog http://trend0.blogspot.com/ is of educational nature and cannot be considered as advice, recommendation or signals to trade in any financial markets.