Basic Stock Chart Analysis – What Is The Wedge ?
Today I’m going to continue our series about basic stock chart analysis; more specifically I’m going to go through a great chart pattern that works with trending markets that are temporarily pausing, before continuing the trend. The pattern is called the wedge and although it has a strange sounding name, I can assure you that it’s one of the best continuation patterns out there. The wedge is often times seen after a strong trend move in one particular direction. The pattern is found is stocks, futures, commodities and currency markets and can be traded using daily time frame or intra-day.
Difference Between A Wedge And Triangle
Often times ascending and descending wedge patterns are confused with the triangle pattern. Although both patterns are very similar, there is one primary difference between the two. The ascending triangle has a flat upper resistance area and the descending triangle has a flat lower support area, while both support and resistance areas on the ascending wedge and the descending wedge are angled towards each other as the wedge pattern progresses. This is the primary difference between the two chart patterns. You can see in this example how different both patterns look when you put them next to each other.
The most important thing you need to know about the Wedge pattern is how to identify it correctly and under what market environment does the pattern provide the maximum chance of success. The first thing you need to know about the wedge pattern is the fact that it’s a continuation pattern. This is very important to know and understand because many books and trading resources will tell you that it can be a reversal pattern as well.
In this particular example you can see how the Falling Wedge Pattern sets up. Notice how the stock is trending strongly before the consolidation begins. Remember, the longer the consolidation pattern the better the trade.
Once you find a strong trending market that’s temporarily pausing, you want to make sure the Falling Wedge develops properly. The Wedge can take anywhere from 2 weeks to 4 months to develop correctly. Always look at the previous trend to get a good idea of the length of the Wedge. For example if the trend prior to the Wedge lasted over the course of one year or longer a Wedge taking several months to complete is not uncommon. If the trend only lasted a few short months then the Wedge should only take a few weeks to develop.
You can see once again how the length of the trend has a substantial factor in how long the Wedge develops. In this example the stock was moving up for about 1 year prior to enter a consolidation pattern. You should expect a good two to three months for the full Wedge to complete. The longer the consolidation or the Wedge pattern takes the better the odds of a strong trend in your desired direction.
You should wait for the stock to completely breakout of the Wedge prior to entry. You can see in this example how we completely wait for the Wedge to trade above the upper resistance area before entry. The stronger the breakout the better the chance of a meaningful move straight up.
Thus far we covered the Falling Wedge which is a common consolidation pattern in a rising market. The Rising Wedge is a consolidation pattern that forms in a strong down trending market. Both patterns are similar with one exception, the Rising Wedge takes less time to form than the Falling Wedge. This is not an absolute rule but something many professional traders have noticed over the years. In this example you can see how a good downtrend is essential before the formation of a Rising Wedge.
In this example you can see how the stock breaks down after trading in a rising consolidation for three straight months. Remember that Rising Wedges may have a bit more volatility and may last a bit shorter than the Falling Wedge. Breakdowns that are accompanied by gaps are especially promising candidates. Markets that breakdown strongly have the best chance for continued momentum.
Make sure you understand the difference between the Wedge Pattern and the Triangle Pattern. Keep in mind that Wedge Patterns can take anywhere from two weeks to 3 months to develop and this is largely dependent on how long the trend lasted prior to the development of the Wedge. Also remember that Rising Wedges tend to be more volatile and last a bit shorter than Falling Wedges.
Before I finish this tutorial I want to show you one last example of a small startup company that may be at the last stage of a Rising Wedge as we speak. I offer no promises and no guarantees but don’t be surprised to see a breakdown in the coming weeks ahead. No it’s not a start up, its Microsoft one of the biggest companies in the world.
Thanks for joining us for today’s tutorial. Next time I will cover how to measure your profit target and where to place your stop level when trading Wedge Patterns. For more articles on the similar topics please see: Technical Trading Strategies – The Tail Gap Strategy Revisited and The Best Technical Analysis Method
All the best,
By Roger Scott