How to Trade Wedges (Continuation Patterns)


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Video Transcript:

Hello, traders. Welcome to the third module of the advanced technical analysis course: chart patterns. In this lesson, we’re going to teach you how to trade wedges. Wedges are very strong reversal patterns. You can also find them as a continuation pattern, but we are mostly going to be focusing on wedges as reversal signals on this advanced course. On this lesson, we’re going to teach you how to trade them. We’re going to have the example of a rising wedge at the top of an up move, but the same basic trading analysis can be applied to the rising wedge at the end of a down move.

So, let’s start. Wedges enter stop losses and targets. This is how we trade wedges. Of course, as with any other chart pattern, we wait for the breakout of the wedge to trade it. A wedge is a consolidation pattern, and you should avoid to trade inside of it. Remember that the wedge is a consolidation pattern that narrows at the end of it before the breakout. So, what we are looking here is an explosion to the downside on a rising wedge or to the upside on a falling wedge to trade the momentum and counter trend trade. So, trading inside of the wedge is really not a profitable strategy for us. Remember that as traders, we look for big directional moves with a lot of volume and momentum for us to be able to profit. The right way to trade a wedge is to wait for the breakout.

How to trade wedges

Now, here’s an example of a rising wedge. We are clearly on an up trend here and we start to make higher highs, but the higher lows are much steeper. This creates a pattern that narrows at the end of it, which we call a wedge. We wait for the breakout to counter trend trade. Now, where to put the stop losses? Remember that stop losses are levels that should be put at a price that completely invalidates our trade idea, in this case, our short idea.

When we have a breakout and an entry the stop loss should be below the wedge of support in a bullish move or in a falling wedge. And, in a bearish move, or bearish breakout, or rising wedge, the stop losses should go above the wedges resistance. And in this case, the stop losses should go here. As you can see, here, we have the last high of the wedge. When we have the breakouts we should go short, right? If we fail to go lower and the price reverses on us and breaks with this high, this pattern is no longer valid because this structure has been broken to the upside, so we need to get out of our short position as soon as possible. This is why we choose this level as our stop loss level.

Now, for the targets. When calculating a wedge’s breakout target, you should look for the previous zone of strong support or resistance. Your targets should be there because you will most likely find strong bullish and bearish pressure there. Let’s have an example here. As you can see, we are in an up strong move, and then we corrected to the downside before making this high. When we break with this wedge right here, our targets should be around these previous lows and highs because it’s more than likely that we will find some buyers here that will try to push price higher. In the contrary or on the bullish side, if we are trading a falling wedge, we should be putting our targets at the previous area of resistance.

Now, let’s look at a trade analysis or a live example of a rising wedge. As you can see here, we are in an up move. We are making higher highs, higher lows, and a new high right here. This is a by-the-book definition of an up move. Then, we make a higher low and a higher high, and then a higher low. As you can see, the lows are steeper than the highs, which means that we are trading inside of a wedge, and which means that the bullish pressure is surrendering against a bearish pressure found at these levels right here.

How to trade wedges in Forex

So, what do we do? The first thing we do is we calculate the targets, which will be the previous lows right here. Our previous lows are the targets because it’s more than likely that we will find some support here, some bullish pressure that will try to take price even higher because we were in an up move. Remember that we are counter trend trading, and we just want to profit from the momentum of the break up to the downside after this consolidation right here at the strong bearish pressure that we have encountered. We are not looking for an enormous move to the downside. We are just looking for the correct targets to profit from the momentum and a strong breakout to the downside, so we pick the previous low as targets.

Remember that if we were on the opposite side, if we were on a down trend and we were trading a falling wedge, we would pick the previous highs as targets, okay? But here, we are looking for a bearish breakout. And, when we get the bearish breakout right here, we go short. And, we go short. And, as you can see here, our targets are hit. Even if price moves a little bit lower or much more lower than our targets, you should stick with your trading plan. Our trading plan was to profit from the momentum of this breakout to the previous lows. And basically, this is how you will be trading a rising wedge. And of course, our stop loss should be above this high because if we break to the downside but fail to break with the wedge structure and break with this high we are still in an up move and our short trade idea is no longer valid here.

Adam

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Adam is an experienced financial trader who writes about Forex trading, binary options, technical analysis and more.

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