What Is A Falling Wedge Pattern
Falling Wedge Pattern Definition
The Falling Wedge Pattern is a "converging range" in a particular security or market price. Many other patterns fall under this category, such as all triangles, wedges and pennants, usually with the qualification that "volume is significant in these formations". These are typically taken to be continuation patterns; however, they are all essentially the same pattern.
These patterns all clearly show volatility compression, which puts traders on guard for breakouts, looking for continuation of any breakout from these ranges.[1]
Falling Wedge Patterns frequently occur as they represent a temporary pause in significant market activity without violating the existing trend. Therefore, It is essential to recognise them and know what to do and what not to do when they occur.
Table of Contents
Falling Wedge Patterns Explained with Examples
The most specific defining characteristics of a falling wedge pattern would be the converging trend lines forming a wedge structure. Converging trend lines are therefore classified as a triangle pattern. Most traders understand this structure to mean that support is holding against a lower timeframe downtrend.
Falling Wedge patterns usually indicate a potential breakout opportunity which may look like the following:
The breakout to new highs
The illustration above indicates the most typical example of what occurs with these patterns. After the price broke out of the wedge, it continued to break past the previous swing high (resistance) and retested it as support before resuming the trend.
Because these patterns are volatility contractions, when price breaks out, it usually moves with momentum. The pullback may not come before first breaking the previous swing high.
To trade this pattern, it would be easiest if you accumulated positions at the touches at the bottom based on a fundamental trade idea that gave reason for the price to breakout. Otherwise, you can have a stop order just outside of the upper trendline to catch the escape as it occurs.
Currency Strength Meters are an excellent and easy way to determine if the chart pattern will play out. Our Macro Currency Strength Meter would be a great place to start.
The illustration above demonstrates the textbook example of what to look for when identifying a falling wedge pattern. The wedge shape is quite visible as both lines are pretty obviously converging-- a sign of an impending breakout.
The test on top of the wedge
Sometimes the wedge would have a short breakout before retesting the top of the wedge, as seen in the illustration above. The top trend line or the nearest horizontal resistance would become support and retested before the breakout continues.
Trading this pattern would be easier for traders who prefer to see that the pattern has formed and has started working before entering. The pullback at the top of the wedge provides this confirmation while still providing a favourable entry price.
How Do Falling Wedge Patterns work?
Falling wedge patterns represent a pause in the prevailing trend, in this case, an uptrend or a bullish market. The inverse is valid for a rising wedge pattern which would be the bearish counterpart. Market participants would have started taking profits or repositioning. Sometimes it may just be that traders are not participating due to a market holiday or a vacation period.
Important: You want to see the volume (in the case of Fx traders, the size of the bars) supporting the direction of the overall trend. For example, if we get a falling wedge in an uptrend, look for the bullish bars (or moves in general) to be bigger and more dramatic than the bearish ones.
Psychologically, these patterns represent an opportunity for traders and investors to join a trend at a fair price, manifesting the breakout. In this pattern, the breakout is merely a resumption of the initial trend with newer (or sometimes more) participants.
The Falling Wedge Pattern is nothing more than a triangle pattern, a contraction of volatility and an impending breakout—a pause in the trend.
Adam Grimes, Trader and President of Talon Advisors, LLC, describes wedge patterns and similar triangle structures as basically the same pattern. They are volume contractions.
"Whenever a market makes a very large, sharp movement in one direction, followed
by a similar move in the other direction, this suggests confusion on the part of market
participants as they try to process whatever information caused the price shock. The
normal expectation, following this kind of price movement, is for the market to spend a
period of time consolidating, most likely in some kind of converging triangle formation.
It is very common to see traders incur multiple losses in these areas because they are
first drawn to the market by the large price movements, and then they get caught in the
random oscillations of the triangle. Simply by recognizing that a large spike followed by a
quick reverse spike usually leads to a triangle"[2]
Falling Wedge Patterns - What They Mean for Retail Investors
These patterns mean that retail investors and traders don't need to experience FOMO (Fear of Missing Out) when we see that something has run away from us. If we missed the opportunity to join a trend, this pattern is only one of many indicating that markets move in waves. Prices will be favourable again.
Falling Wedge patterns can also be entered aggressively (from the breakout) or more conservatively (from the first pullback after the breakout), which means that they're pretty dynamic and usable by traders with different entry criteria in their trading plans.
This pattern is just another tool in the technical analysis toolkit to help us get involved once we believe we've done our research and have our trade idea ready.
Article Sources
Adam Grimes. "The Art and Science of Technical Analysis," Page 132. Wiley, 2012.
Adam Grimes. "The Art and Science of Technical Analysis," Page 134. Wiley, 2012.
