Wedge Breakout Forex Strategy
Hey, traders. Welcome Video 8 of the Advanced Forex course. This is Cory Mitchell. In this video, we are looking at the wedge breakout strategy. We can use this on all timeframes. Brought to you by Investoo.com.
So, trend trading is where the money is. There are multiple ways to trade trends. This is a reversal strategy similar to the trendline break strategy. As always, a low risk relative to reward potential can be used on all timeframes. On longer timeframes, you may not see this pattern too often since it takes multiple price waves to align to create a wedge.
In the examples, we’ll look at what exactly a wedge is. So, we trade in the direction of the trend, in this case, a probable new trend. The wedge and evidence that we’re looking for suggest that the trend is reversing. So, that is why we’ll take a trade in the opposite direction of the trend. In this strategy, we can set and forget. No touch-touchy. Once we have our entry set, our stops, and our targets, that’s it. We let math do the work. Our profit targets are bigger than our losses.
So, isolate an ascending wedge. This would be an uptrend. So, we’re going to look at exactly what that is. But, basically the wedge is characterized by waves higher, which are smaller than the last wave. So, basically, you can think of it, it’s almost like a funnel where the price is just narrowing and narrowing, but it’s within an uptrend.
So, the price is making the overall movement higher, yet it’s getting squeezed as it does so. We’re waiting for the price to break below the wedge, should fail to make new highs. That is the only confirmation we need. The order doesn’t matter here. So, it can be a new high or fail to make a new high within the wedge and then break out, or it can breakout and then fail to make a new high. We do wait for the price to be outside the wedge before we can look for entry. We can either use the pause method, which we discussed basically in one of the first videos when we were just looking at trends, or we can use the pocket strategy. The stop is 5 pips above the wedge high; targets are 1.6 and 2.6 times our risk.
The wedge indicates a reversal, but is unproven when we take the trade. Therefore, we only use two targets, and don’t get greedy expecting a massive reversal. As you can see, though, we’re still making quite a bit more on our winners than we are on our losers. As you can see, if we take two positions, we’ll end up with 2.6 times our risk. As always, we do try to take two positions instead of taking one position. For too many lots, take two positions for one mini lot each. Risk must be kept below 1% on all orders, and that is cumulative.
So, we can isolate a descending wedge, which is a downtrend. That would be the price is moving overall lower, but the price is getting squeezed. The waves lower are getting smaller than the last. Wait for the price to break above the wedge, or should fail to make a fail to make a new low. That’s the only confirmation we need, and once again, the order doesn’t matter. We do wait for our entry to enter outside the wedge, so we look for the price to pause, or we can throw a pocket strategy entry. Stop is 5 pips below the wedge low using the same targets 1.6 and 2.6 times the risk. Keep risk below 1%.
So, let’s look at the downtrend first. We have the Euro/JPY up here. I do have to go back a ways to find kind of a nice wedge pattern as indicated on a longer-term chart. We’re looking at the four-hour. These might not come up too often, simply because it does take multiple waves to sort of align as they’ve done here. And you can see it’s starting to funnel. Even though the angle of this is very strong down, we can see that it’s starting to lose a bit of momentum.
We have a very strong wave, then a bit smaller wave, and then a bit smaller wave. So, that’s what creates this funneling-type appearance of these lines. So, we have a pause and then we have a breakout. So, here is when we’re starting to look for trades, but we still need one more piece of confirmation and that is a higher low. So, it pulls back here. We have a higher low. Beautiful. Now we can look for an entry.
So, if we used the pocket strategy, one of the easiest to use in this case, we would have been looking for an entry in this area here, simply because this is the pocket area of the last down wave. So, by putting an order out there, we catch any sort of last bit of selling in anticipation that this is going to occur. So, that way it worked out very well. We do not get enough of a slow down to give us the pause method. We have the pop higher. We would have needed to see a few bars down, and then this would have needed to pause here, and then we could trade a breakout, but it doesn’t happen.
So, the pocket strategy, as I mentioned in the pocket strategy video, it’s one of my favorite entries, simply because you get great price. You won’t always get filled, but when you do, you get a good price. So, this one, and originally our stop is below the wedge low, about 5 pips below. So, we can see the low there is 23.136-23.2-so we would drop that down 5 pips below that.
So, we are looking at entering right about here. Our order would have been set out waiting for that entry there, and we are looking at almost exactly 90 pips of risk. So, 90 pips times 1.6. If we have enough room for two positions or whatever it is, two micro lots, two mini lots, whatever you can afford, we’d be looking for our first exit at 144 pips. So, that would be right about here, first target. And then, 90 pips times 2.6, 234 pips. Remember this is a four-hour chart. This is why we’re getting some bigger moves. So, 234 pips would have been right about there. You can see this one produced more on our winners than we would have on our losers, and that’s the kind of strategy we want.
All right. So, then we had an upward wedge not too long ago in the USD/JPY. And this is, once again, a four-hour chart. As you can see again, we have this stronger on higher followed by a little weaker on higher, followed by a weaker on higher, which creates this funnel-like appearance. The price moves outside of the wedge. Still, that doesn’t really provide us with a ton of confirmation, but then we do have this here. It basically meets the same high then drops away, makes another run.
So, here, we could have used the pocket strategy. Once this price dropped away, we would have put out an order out right here, so we would have had fill basically on this bar, based on that pocket right there. Here is our stop, 5 pips above. So, we are entering right there, target of roughly, we would say, 16 pips times 1.6.
So, from our entry point there, we’re looking at a 25.6-pip target. That would have been right there. What we’re looking at 16 pips times 2.6. So, our next target would have been at 41.6 pips. And it looks like that would have got filled on that bar right there, actually here. [Inaudible 08:57] your spread you may have gotten out of that. Otherwise, you would have been maybe in this for a little bit longer until we got out on that bar right there.
So, as you can see, 1.6 and 2.6, they’re pretty conservative. Sometimes you will have a little bit more room to the downside, but we want to get out of this. We’re not sure if this trend is going to continue to reverse all the way or if it’s just a deeper pullback. So, all we’re doing is betting on a deeper pullback which this occurs. These would be shallow pullbacks as we can see. So, we’re betting on something more substantial.
We have the wedge and a lower high to confirm it in this case, and just looking for a bit more downside to come. If we would have tried to go for more, we probably wouldn’t have hit our targets, and we would have eventually been stopped out here. So, don’t get greedy; just take the targets that we can. In this case, once again, we have the pocket entry. We do not have a pause entry. We potentially had one sitting up here. Once this moved lower, we had a little bit of a pullback. So, all we’re doing is waiting for a pause that we can trade or break lower. But we need at least four bars. One, two, three, and we break out.
So, if this would have lasted, if this would have paused for a couple more bars and then broke lower, then we would have had the pause entry based on that area right there. But, it doesn’t pause quite long enough to give us confirmation so the pocket entry would have worked well in this one. If we did have that pause, then you could have used the pause breakout method.
So, we’ll review every trade as a stop and a target. Place these orders when you place the trade. We only risk 1% of our account in any one pair. Taking multiple positions to get out at different targets counts as one trade. So, even though it may take whatever your position is, two mini lots, two positions of one mini lot each, the risk on those two positions must add up to less than 1% of your account. That way, a string of losses won’t significantly draw you down.
Only trade in the trending direction. In this case, we’re betting on a new trend or at least a short-term shift in direction. The wedge helps us to confirm that. We place the stop 5 pips below the wedge low. Place the stop 5 pips above the wedge high. Targets are 1.6 and 2.6 times the risk. Even if we are taking different entry prices, we didn’t really discuss that, simply because we’re using the pocket strategy mostly or the pause breakout. The Fibonacci entries really wouldn’t work on this, simply because we’re looking at too small moves for them to really be relevant. So, we take 1.6 and 2.6. And we’re not getting greedy; we’re just expecting a short-term reversal. We don’t know if it’s going to be a full fledge reversal yet.
Optional, we reduce risk to breakeven on remaining positions once the first target is hit. We don’t have to do that. It’s simply something if you want to do, you can. Trading involves substantial risk of loss. Only trade with capital that you can afford to lose. Test out strategies before using them to make sure you’re actually able to implement them yourself and in real time. So, work on this in a demo account, draw the wedges, isolate them, and look for these sorts of entries. Go through the other videos if you need to, to see how these entries work again and practice, practice, practice. Until next time, happy trading.