One of the pillars of technical analysis is the idea that market mentality is mob-like, that price movements often repeat themselves and that those movements are identifiable and predictable. According to technical analysts, one way to predict the future is with the patterns. One of the said patterns is the Wedge Pattern. The Wedge Pattern appears on a trending market and is considered by some to be the sign of a long-term trend continuation.
How does a Wedge Pattern look like? It looks like a sidelong triangle. A Wedge Pattern is formed when the channel in which the asset price fluctuates, becomes narrower. It usually takes more time for a wedge to fully appear on the price chart than a triangle and the magnitude of the pattern will be much greater. For example, on a daily chart, a flag or a pennant may take from a few days to a few weeks to form. The wedge may take many weeks to form.
Magnitude is very important with this particular pattern and any technical pattern in general. Basically, the magnitude is the size of the pattern. The magnitude is important because it is used to estimate payout targets once the pattern is broken.
How is it formed?
A wedge is built by the seesaw price movements between the upper and the lower boundaries of the price channel. It is caused by the difference between buying and selling pressure. In case of an uptrend, prices may reach a peak where bullish traders close their deals with a surplus or when bearish traders open new deals. After the initial sell-off, which may last from one week to several, bullish traders step back into the market to take advantage of relatively low prices. The price action will then move back up to another peak. However, this time the peak will be lower due to the growing presence of bearish traders.
Back & forth price movements represent the struggle between bulls and bears. In case of a bulls-dominated market the buyers are supported by fundamentals while the bears are driven by their fears. Eventually the bulls will overtake the bears because they have strength in numbers (bulls tend to be more numerous on almost any market). When it happens, prices may break the wedge pattern and continue moving higher. The breakout is an entry signal. However, it should be confirmed by other indicators.
How to trade it?
The answer is “very carefully”, at least until you spot the breakout. When the breakout is imminent the continuation of the prevailing trend may be expected. Before the breakout traders can take advantage of price swings that form within the wedge for short-term trading opportunities.
Now, how is this pattern related to other patterns? As already mentioned, the Wedge takes some time to develop, which is usually much longer than similar flag or triangle patterns. Here is the good news: since short and long terms are relative, a wedge on one chart can be treated as a triangle pattern on another. You can think of it like this: a flag or a triangle on a weekly chart are a short-term signal for this chart, but when you treat this chart as a long-term chart the signal becomes a long-term signal. A flag or a pennant on a daily chart, when brought into light on an hourly chart, can turn into a Wedge Pattern.