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Introduction
Wedges are one of the most common patterns to be found when trading and they are of two types: rising and falling wedges. There is a saying that a rising wedge is falling and a falling wedge is rising. Well, this is certainly true most of the times, however, there are some cases when a rising wedge, being part of an intervening x wave in a double three running combination for example, is only briefly corrected, only for price to move strongly in the direction of the initial wedge.
So, while the statement that a rising wedge is falling and a falling wedge is rising still holds true, the question is: are wedges reversal patterns, and if yes, what are the things to look for in a wedge to consider it a reversal pattern?
Trading Strategy
Wedges have the tendency to travel between the 1-3 and 2-4 trend lines if we are to take into consideration Elliott Waves Theory and, when they are forming an ending diagonal, each and every wave out of those five waves that form a wedge should be corrective, meaning they should come in a corrective shape: zigzag, flat, triangle, etc.
The same theory states that the third wave in an ending diagonal that comes in the form of a wedge should not be the shortest one, and this allows a trader to have an educated guess about the possible end of the wedge, in the sense that, by measuring the length of the third wave and applying the outcome on top of the fourth wave, the result should give us the maximum value for the upcoming fifth wave. This is an important competitive advantage such a pattern offers because if price extends beyond that level, the implications are that the third wave is not the shortest one anymore, hence the structure you are looking at is not a wedge.
The chart above shows a rising wedge on the eurjpy pair and it marks the beginning of the wedge on the lower left and the end of the wedge at the fifth wave highs. There is a clear five waves structure and the legs of the wedge are coming in corrective patterns (zigzag for the first wave, contracting triangle for the second, zigzag for the third, flat for the fourth, and yet another zigzag for the fifth).
The first wave being the longest and the fifth the shortest, it implies the third is not the shortest one of the three waves that are rising, so this is a valid ending diagonal in the form of a rising wedge.
Like mentioned earlier, wedges are travelling between the 1-3 and 2-4 trend lines, so waiting for the lower trend line (in the case of a rising wedge) or the upper trend line (in the case of a falling wedge) to be broken is mandatory. However, what to do next? Is there a measured move for wedges?
Trading wedges without taking into account the time element is one of the biggest mistakes traders make, and we want to avoid that by all means. In order to do that, just measure the time taken for the whole wedge to form and project that time on the right of the chart, from the moment the wedge ends.
After the lower trend line (2-4 trend line) in a rising wedge is broken, look for price to retrace to the fifty percent level from the whole wedge, in less than the time taken for the whole wedge to form in the first place. If, after you are projecting the time on the right side, the fifty level is not retraced and the time element is expiring, the pattern you are looking at is most likely not a wedge.
The chart below is the same eurjpy chart and it illustrates the strategy as described above.
Conclusion
Wedges are tricky in the sense that the vast majority of market participants are looking for them to be reversal patterns, but this is not mandatory. The best to be taken out of a rising or falling wedge is to look for the fifty percent retracement to come after the 2-4 trend line is broken, and this should come in less time than the time taken for the whole wedge to form and the highs established at the fifth wave should hold for this whole period.
Source: this article is a contribution by John from Forex Brokers Hub, the site which features detailed reviews of the most popular Fx brokers.
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