The Wedge is a very popular reversal pattern that appears not only in Stocks but also in FOREX pairs and commodities. It is a counter-intuitive pattern – it usually breaks in the opposite direction, and is also traded in a very different method than most patterns (hint: not breakout). After reading this article you will have a better understanding of the mechanics of this pattern.
A Wedge consists of two trendlines that are in the same direction (both rising or both falling), with one trend line steeper than the second.
A Wedge usually breaks in the opposite direction of its trend. It is confirmed when one of its trendlines are broken.
The main idea behind the pattern is of a retracement. After a steep trend with strong momentum, price stops to gather its forces and continue the trend. The pause in trend is reflected in the wedge pattern.
The Wedge pattern can be compared to the channel pattern. While at the channel the trend lines are parallel and reflect a strong and healthy trend, at the Wedge the trend lines are not parallel and signal that the trend is not ‘real’ and will reverse.
Because the pattern is a representation of a retracement, we should look for weaker volumes at the wedge itself, in relation to the earlier trend.
How To Trade
The Wedge is traded in a different than most patterns. Contrary to most patterns, trading the breakout or pullback at the Wedge are not profitable and result in many losses. Do not trade breakouts or pullbacks at Wedge patterns.
Instead, when spotting a Wedge pattern look for a support or resistance level that price may stop on. It will be a support level at descending wedge or a resistance level at a ascending wedge. Wait for price to touch that level and reverse – and enter the trade. Make sure the level is strong enough to reverse the trend.
BONUS: A good place to spot reversal levels is the Fibonacci retracement levels. Using the Fibonacci tool, draw the retracement levels on the trend. Wedge pattern stop on retracement levels on many occasions – and they serve as a good spot to take trades on.
Calculating profit targets to the Wedge pattern is not done with the measure rule, as in many trades price does not reach the projected target. Instead, set the target to the previous high of the trend. If you have entered at the reversal levels like instructed above, you should have trades with very good risk:reward ratio.