What is the Wedge Pattern?
One of the pillars of technical analysis theory is the idea that market mentality is mob-like, that price movements will often repeat itself and that those movements are identifiable and predictable. One such is the Wedge Pattern. The Wedge Pattern forms in a trending market and often signals continuation and not just any continuation, but a long-term continuation that will lead to payouts.
What is a Wedge Pattern? A Wedge Pattern is a form of triangle that forms within a trend, like a flag or pennant pattern but with a much long-term time horizon. It usually takes a wedge much longer to form than a triangle and the magnitude of the pattern will be much greater. For example, on a daily chart, a flag or pennant may form over the course of a few days or weeks, less than a month, while a wedge may take many weeks to form.
Magnitude is very important with this pattern and any technical chart pattern. The magnitude is the size of the pattern. In case of forex this may be counted in pips, in case of equities, cryptocurrency or indices they would be counted in dollars/euros or percentage points. The magnitude is important because this is how you project price targets once the pattern is broken.
How does a Wedge form?
A wedge forms from the see-saw action between bullish and bearish traders. In the case of an uptrend, prices may have reached a peak where bullish traders have payouts and/or bearish traders begin selling. After the initial sell-off, which may take a week or more, the bullish traders step back into the market to take advantage of low prices. At this point price action moves back up to another peak, but this time the bears step in a little sooner and begin driving prices back down again.
What the back & forth in price movement represents is a struggle between the bulls and bears. In the case of a bull market buyers are supported by fundamentals while the bears are driven by fears. Eventually the bulls will win out because they have strength in numbers, there are always more bulls than bears in a bull market. When that happens, prices will break out of the wedge and begin to move higher. The break out is the indicator for entry and will be confirmed by other indicators.
How to trade the Wedge Pattern
Very carefully, at least until the break-out of prices occurs. Once the break out occurs you can be assured of a sustained continuation of the prevailing trend, a continuation in which trend following signals will form frequently, with regularity and a high degree of reliability. Before the break-out traders can take advantage of swings within the wedge for shorter term trading opportunities.
Now, how do related a Wedge Pattern to different time frames? Very easily I must say. A wedge on one chart is a triangle or flag on another. Think about it like this; a flag or triangle on a weekly chart is a short-term signal for this chart, but it’s a long-term chart so the signal is really a long-term signal. If you drill down to the daily chart that flag may look more like a wedge as it comes into focus. The same is true with a daily chart. A flag or pennant on the daily chart, when brought into sharper focus on an hourly chart, looks like a nice, tradable, Wedge Pattern.