There is only one reason to learn to trade a chart pattern: to make more consistent predictions about future price action.
Unfortunately, there are many patterns that traders spend time learning and memorizing that either don’t occur that frequently, or worst, they aren’t that predictable!
Here I’m going to share with you a pattern that breaks bullish 68% of the time! Now that’s predictable!
So what is this mysterious pattern that seems to foreshadow such great fortunes?
I’m talking about the falling wedge.
Wedge patterns are fairly well known. But what most people do not realize is true wedges are somewhat rare but extremely predictable!
There are two common problems we see with identifying wedge patterns:
Both of these challenges lead to a lot of confusion surrounding wedges, and consequently, it leads to some bad “experiences” trading wedges. After-all, if you identify something as a wedge that is not a wedge you can’t expect it to play out like a wedge!
There are two types of wedge patterns:
I’m going to explain the details of each and then we will look at how they are often confused with triangle patterns and pennants.
The first thing you need to know about wedges is this: they are counter-intuitive.
The rising wedge is rising (as the name suggests) but tends to break bearish, and the falling wedge is falling (as the name suggests) but tends to break bullish. So at first glance, they can be misleading. But when you learn to recognize them they are super helpful because you can actually get into the trade in the opposite direction very early.
The rising wedge exhibits the following characteristics:
Let’s break this down with some visuals.
First notice support and resistance are converging in on each other while both are trending higher:
Next, notice the size of this pattern. It is a small pattern that is much smaller than a triangle type consolidation pattern. And when the pattern finally breaks, it tends to break bearish.
Another important feature to recognize here is the fact that a rising wedge can occur in either a bullish or a bearish trend, it is trend agnostic. That’s why we can not specifically say it is a continuation or a reversal pattern. What we can say is the rising wedge tends to break bearish. So if it occurs in a bullish trend, it tends to break bearish and functions as a reversal pattern. But if it occurs in a bearish trend, it will also tend to break bearish which would appear as a continuation pattern.
Rising wedge patterns do not occur all that often when compared with patterns such as a flag, pennant, or double top. But they do occur with a fairly good consistency and they are very predictable in the direction they break - BEARISH!
So what should you do if you see one?
Draw the pattern on the chart and set a trigger to enter you into the trade if/when it breaks to the down side. Eventually, the pattern has to break and the odds are high it will break to the bearish side. So be prepared with your order and once you get the signal, take the trade while placing your stop above the recent swing high.
So now that we understand the rising wedge it should be fairly simple to invert the image and turn it into a falling wedge.
The falling wedge exhibits the following characteristics:
Let’s also break this pattern down with some visuals.
First notice support and resistance are converging in on each other while both are trending lower:
The only real difference in the rising and falling wedge is:
Notice the size of this pattern. Like the rising wedge, it is a small pattern that is much smaller than a triangle type consolidation pattern. And when the pattern finally breaks, it tends to break bullish.
Like the rising wedge, the falling wedge can occur in either a bullish or a bearish trend. The key is to remember that it tends to break out bullish.
How often does this pattern break bullish?
According to the famous chart pattern statistician Thomas Bulkowski, the falling wedge breaks bullish a staggering 68% of the time, making it the most predictive chart pattern in our arsenal of chart patterns! In my own trading, this statistic seems to hold pretty close to accurate!
(Note: For years I have quoted the statistic of 92% as opposed to 68%. Recently Bulkowski has changed his research findings to reflect 68%. In my experience, this pattern breaks bullish at least 68% of the time, but probably more)
So what should you do if you see one?
Draw the pattern on the chart and set a trigger to enter you into the trade if/when it breaks to the up side. Like all patterns, the falling wedge eventually has to breakout and the statistical odds are high it will break in a bullish direction. So be prepared with your order and once you get the signal, take the trade while placing your stop below the recent swing low.
By far the most confusing part of identifying wedge patterns is the constant confusion between what makes a wedge, a triangle, and a pennant.
In a nutshell, it comes down to one thing: size.
Size is the biggest differentiation as well as the angle of the support & resistance lines. That’s the visual distinction. Functionally speaking they are very different.
So functionally speaking what is a wedge? Well, a rising wedge breaks bearish and a falling wedge breaks bullish. It’s hard to give it a function because they can occur anywhere and function in various capacities. BUT, they have predictable breakouts, which is why they are valuable to recognize.
Notice the size difference of these three images. They all three have a different visual look.
Notice the Triangle is large. It is a consolidation pattern that technically you could trade within the boundaries like a channel.
Take a look at the pennant. It is tiny. Pennants usually only last a few days and they almost always continue the preceding trend. So if the preceding trend was bullish, the pennant tends to break bullish. If the preceding trend was bearish, the pennant will tend to break bearish.
The wedge, on the other hand, is much different. It’s larger than the pennant, but not nearly as large as the triangle. More importantly, only the wedge has the lines moving in the same direction while converging on each other. That is another distinction of the wedge. And of course functionally, the wedge can be a reversal or a continuation all depending on which type of wedge forms.
I will reiterate one more time: The most important thing to recognize about wedge patterns is the reality that:
If you can remember these details and learn to find the patterns, they will serve you very well and you can make a lot of money placing great trades on the breakout of these patterns.