The Wedge Chart Pattern | Trading Strategy

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Introduction

This is part two of an article regarding rising and falling wedges. This first article explained what rising and falling wedges are and what type of wedge filters are available in chartmill.

Mind you, really good rising and falling wedge setups don't happen that often. What is really important is that the two lines of the pattern strongly converge to each other and that one of the two lines has a clearly stronger degree of rising or falling than the other line. As a reminder, in a rising wedge, it is the lower trend line of the pattern that rises faster than the upper one. In the case of a falling wedge, it is the upper line that is falling more sharply than the lower one. see the images below.

risingandfallingwedge

In this article we’ll cover two different ways to enter the market after a falling wedge pattern.

Breakout strategy

Let's take a look at the chart of Costamare Inc (ticker: CMRE) on date of April 21, 2021.

CMRE_chart

On the daily chart, only the ChartMill Trend Indicator is visible. Green is bullish, gray is neutral and red is bearish. Since the last week of March the indicator has been gray (neutral) because of the rather sideways movement that the price is making. Furthermore, there is a descending price channel, delineated by the two blue lines. Notice how the upper blue line has a clearly stronger rate of decline than the lower blue line. Both lines run towards each other. This leads to the typical wedge shape from which this pattern emerges.

A few days later, on date of April 26, 2021 the chart looks like this:

CMRE_chart 2

At the top of the price pattern a doji candle formed with considerable volume. As a matter of fact, the price opened with a gap-up that day. This was a clear first attempt to break through the upper blue trend line. The uppertail of the doji candle is very pronounced and a sign that sellers had the upper hand at that price level. Nevertheless, the price was still able to close that day on a positive note. After that day it was clear that the high of the doji candle had become a very important price level. After all, if buyers would manage to overcome the high of this doji candle fairly quickly, the remaining distance to the next price resistance, at the level of $10.6, could go quite fast.

CMRE_chart 3

Already the next day the high of the doji candle is taken out.

  1. Entry buy zone
  2. Initial stoploss zone
  3. More aggressive stoploss zone / adjusted stop after first price target is hit
  4. First target

Retracement Strategy

Not everyone likes breakout strategies. This is exactly why there is a second option when trading wedges. The Retracement strategy will not enter at the first breakout but instead will wait for a price drop. The disadvantage is that you will not always get the chance if the price suddenly keeps rising. The big advantage is that the setup in terms of risk/reward is usually much better.

In the example of CMRE, the price first rose to $11.39. Afterwards the price drops again to the level where it previously broke out of the rising wedge.

CMRE_chart 4

The $10 price level acts as support. Sellers were trying to push the price down but the two consecutive hammer candles with long undertails were a clear indication that buyers were entering the market.

CMRE_chart 5

The following day, a doji candle formed with an upper and lower tail. Moreover, the closing price was exactly the same as the opening price. So there was a lot of price movement involved. These are the ideal conditions for a low-risk buysetup.

CMRE_chart 6

  1. Entry buy zone
  2. Initial stoploss zone
  3. First target

Eventually the price continued to rise and the first target, which coincided with the top of early May, was reached. After a few days of sideways movement, a long white bullish candle formed whose closing price was above the top that had been in place until then (blue highlighted candle). That was the signal that the stoploss of the long position could be raised at least just below that blue marked zone. At the same time the position could be extended at that level if desired. Eventually, the price continued to rise to $12.6.

CMRE_chart 7

When to get out?

There are several possibilities for the exit. Above we have set a price target but you can also use an ATR stop or a swingpoint stop.

In the chart below I have added a "3-ATR stop" at the first breakout strategy (green rising line).

CMRE_chart 8

  1. Entry buy zone (breakout from rising wedge pattern)
  2. Stoploss zone (agressive)
  3. Exit (3 Average True Range STOP)

In the example below, a "5BP swingpoint stop" was added after the entry at the retracement strategy following the rising wedge pattern.

CMRE_chart 9

  1. Entry buy zone (retracement after breakout from rising wedge pattern)
  2. Stoploss zone
  3. Exit (5 Bar Pattern STOP)

To the right of this article in the 'related articles' column you will find more details about the 5BP and 7 BP swingpoint stop and the ATR stop (or click the direct links in this article).

Through this link you can watch a video which shows how you can add both stops directly into the chart and how you can use these two types of stops to keep your winning positions longer in the market.

These two simple swing trading strategies are based on the daily charts. You can, of course, apply them to any timeframe, as long as the pattern is clearly identifiable. A good rule is that if you have to look too long on the chart before you "see" the pattern the setup is probably not really worth it. Definitely keep that in mind!



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