Those traders who have been waiting to buy the market leap in and send it skyward once more. Leveraged trading in foreign currency or off-exchange products on margin carries significant risk and may not be suitable for all investors. We advise you to carefully consider whether trading is appropriate for you based on your personal circumstances.
This wedge could be either a rising wedge pattern or falling wedge pattern. The can either appear as a bullish wedge or bearish wedge depending on the context. Thus, a wedge on the chart could have continuation or reversal characteristics depending on the trend direction and wedge type. The price finally breaks above the upper line, indicating that buyers are taking control.
What is a falling wedge pattern?
Also known as the descending wedge, the falling wedge technical analysis chart pattern is a bullish formation that can occur in trend continuation or trend reversal scenarios. It forms when an asset’s price drops, but the range of price movements starts to get narrower. As the formation contracts towards the end, the buyers completely absorb the selling pressure and consolidate their energy before beginning to push the market higher. A falling wedge pattern means the end of a price correction and an upside reversal. Together with the rising wedge formation, these two create a powerful pattern that signals a change in the trend direction. In general, a falling wedge pattern is considered to be a reversal pattern, although there are examples when it facilitates a continuation of the same trend.
With both strategies, your stop is far closer than the point at which you take profit. This is one reason why pennants are so sought after by traders – relative to other patterns, the risk-reward ratio tends to be high. For our EUR/USD trade, for example, you might be risking 10 or 20 points in exchange for 200 points of potential profit. If you’ve waited until the market retests its old area of support or resistance, you’d place your stop a few points below your entry position. You’ll want to give enough room for the price to oscillate before any breakout takes hold, but not so much that your losses are too great if the pattern breaks.
Strategies to trade wedge patterns
Both scenarios contain different market conditions that must be taken into consideration. They can offer an invaluable early warning sign of a price reversal or continuation. Knowing how and why the falling wedge pattern forms are essential to learning how to trade it. Now that we have had a closer look at the definition and psychology, it’s time to have a quick look at how many traders approach the rising wedge pattern.
In general terms, trends that have been persisting for longer periods of time, will be more robust and harder to break than trends that haven’t been in play for so long. Continuing our EUR/USD example from earlier, say that the market had risen 200 points before pausing. Once it breaks out beyond resistance, technical traders would expect it to make another 200-point move. In a bearish pennant, strong negative sentiment causes a market to plummet lower (forming the pole). The sellers that have pushed its price down might then back off and take profit, while bulls sense the potential for a bounce back. The bullish pennant pattern can occur over lots of different time frames.
How to trade bullish and bearish pennants with IG
There can sometimes be a correction to test the newfound support level just to make sure it holds and is a valid breakout. This can be seen frequently when day trading; when previous resistance becomes support and vise versa. It is created when the price action forms a series of lower highs and lower lows. It is bullish if it forms in an uptrend and bearish if it forms in a downtrend. The Falling Wedge Pattern is a reversal pattern that occurs in downtrends. It’s easy to spot on a chart and once you know how it works, you can use it to enter trades with the potential for big profits.
When the price breaks the upper trend line, the security is expected to reverse and trend higher. Traders identifying bullish reversal signals would want to look for trades that benefit from the security’s rise in price. For example, if you have a rising wedge, the signal line is the lower level, which connects the bottoms of the wedge. If you have a falling wedge, the signal line is the upper level, which connects the formation’s tops.
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It usually results in a breakout above the upper resistance line. If the falling wedge shows up in a downtrend, it is seen as a reversal pattern. It exists when the price is making lower highs and lower lows which form two contracting lines. The falling wedge usually precedes a reversal to the upside.
Here it can be very easy to get kicked out of the trade for minimum loss, but if the stock moves to the benefit of the trader, it can lead to an excellent return. The image below shows an example of the stop loss placement in relation to the falling wedge. As should be clear, it’s placed slightly below the support level, is falling wedge bullish or bearish to give the market enough room for its random swings. Now, as prices continue into the shape that is going to become the falling wedge, we also see how volatility levels become lower and lower. It’s important not to confuse bullish pennants with other patterns such as triangles, falling wedges and bullish flags.
How long should the preceding downtrend be for a Falling Wedge to qualify as a reversal pattern?
When lower highs and lower lows form, as in a falling wedge, the security is trending lower. The falling wedge indicates a decrease in downside momentum and alerts investors and traders to a potential trend reversal. Even though selling pressure may diminish, demand wins out only when resistance is broken. As with most patterns, it’s important to wait for a breakout and combine other aspects of technical analysis to confirm signals.