Certain patterns, while scanning forex charts, will stand out to you like road signs previewing an opportunity. The wedge pattern, for example, is one of the more reliable patterns you'll see, which can help predict which direction prices might break next.
The wedge is simply a chart pattern formed by two converging trendlines that compress price action in an ultimately tighter range. Think about this in terms of a basketball being compressed into a smaller and smaller tunnel. Eventually, the pressure builds and builds until the basketball pops out one side. This is what happens with currency prices being compressed in a wedge.
Wedges are categorized in two ways: Rising Wedges and Falling Wedges. Each tells a different story regarding sentiment toward the market and the next potential direction. Rising wedges typically show they are losing momentum to the upside; falling wedges often show they have lost momentum to the downside.
Types of Wedge Patterns: Rising versus Falling Wedge
A better understanding of the wedge two types will enable better trading decisions, as both types have personalities and typical behavior.
The rise wedge patterns are occur in an uptrend but come with a bearish warning. Imagine a balloon being further inflated with a tight rubber band that is wrapped around the balloon. Clearly the balloon is getting larger and larger, but with every inhale on the balloon something has to give.
In a rising wedge both the high and the lows are in increasing motion; however, the momentum is diminishing with every new increase in highs and lows. The trendlines converge, and buyers are no longer able to get enthusiastic enough to take prices higher.
How to Recognize a Wedge Pattern in Forex Charts
Identifying wedges on your charts is easy once you know what you are looking for. The wedge formation has some key characteristics that help distinguish it from other patters.
The first thing you will want to identify are the trend lines. You will need two clear lines that converge over time, or at least two swing highs and two swing lows. Think of two chopsticks that get angled inward, trapping a ping pong ball, that pinn pong ball will eventually pop out. You want them to have some slope towards one another (not too steep), indicating a narrowing channel.
Wedge Pattern Trading Techniques for Forex Traders
To trade wedges properly will take patience and discipline to execute all the way. You can't simply recognize a pattern and jump into the trade. You have to wait for a confirmation and make sure you have a plan in place to manage your risk.
The ideal wedge signal is price is consolidating and breaks out either trendline with conviction. Think of the wedge like you're at a starting line with your foot on the pedal waiting for it to go off (the break) for you to sprint to the finish line, before that you are just standing there watching.
Common Mistakes and False Signals in Wedge Trading
Even the most seasoned traders can become ensnared in the traps of trading wedge patterns. By understanding what to look for here, you can avoid making many costly mistakes in your trading, and become increasingly successful over time.
Confusing wedges with other patterns: The most common mistake is to confuse wedges with triangles or flags. This error stems from the similarity in that they all have trendlines that converge. The main difference is that the trendlines of wedges are sloping in the same direction. A triangle or flag has at least one trendline that is horizontal. Take your time and be absolutely sure that you have correctly identified the pattern before acting upon it in your trading.
Key Takeaways and Practical Tips for Wedge Trading
When you start trading wedges, use smaller position sizes. Even when you become confident in your skills of layering the wedge and determining probable price movement - trading live accounts trigger different emotional responses that can erode some judgment.
For advanced traders, here are a few things to keep in mind: Look for wedge confirmation in multiple time frames. A wedge on the 4-hour chart is much more significant if the daily chart is also biased in the same direction. Also, pay attention to the fundamentals that would drive price in the direction of the breakout.
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