The Falling Wedge as a price pattern is fairly common and presents in all markets, time frames, & price ranges. Typically a Falling Wedge is presented as either a bullish trend continuation pattern or a reversal pattern depending on the trading environment in the background. Regardless of environment the contracting, narrowing price range outlined by the Falling Wedge is an indication that the immediate downtrend outlined by the wedge is losing strength and considered to have a definite bullish bias.
Visually Falling Wedges are characterized by a contracting range in prices with ‘converging’ or inclining toward each other trendlines that create lower lows & lower highs. By definition this means the Falling Wedge pattern outlines an immediate downtrend pattern in prices with both the immediate support & resistance trendlines slanted in the opposite direction of the larger bullish trend. The shape of the Falling Wedge is altered by the slope or angle of the descending resistance line which should be steeper than the tighter angle slope of the lower descending support line.
Falling Wedges vary in their duration, but will have at least two swing highs and two swing lows in price. Traders should be prepared to adjust the trendlines as needed with additional swings. Volume usually diminishes as the pattern develops & this becomes one of the best keys to determine when the pattern may break & it represents the bullishness of the formation. If volume remains the same or increases during the wedge formation then the signal will be less reliable. Buyers & sellers create this narrowing range-bound price action and eventually prices squeeze to an Apex. The closer to the apex price gets the odds for a breakout of the immediate price range becomes more likely.
Falling Wedges can be a little tricky to trade but traders can ‘stack the deck’ increasing the risk-to-reward ratio for profits when this pattern presents as one of the best performers statistically - the bullish continuation seen in an uptrend.
The bullish continuation pattern has 3 phases:
1) Background: A Strong impulsive, thrusting action with a surge in volume & price establishes a clear picture of the controlling bullish trend direction. In our falling wedge price pattern it is represented visually by a Pole. Higher and more drama the better as the Pole is the Key to recognizing the potential for the continuation of the bullish pattern. The Pole represents trend direction as well as its strength & often this pattern is initiated as a new breakout in price from an established area & buyers are in control.
2) The second phase is a pause for consolidation of the action both in volume & price and is represented by the falling wedge. As traders we like to see this phase short in duration with only 2 or 3 swings while our price action is range bound maintaining the lower lows & lower highs shape and the volume is ‘resting’. Again, pay close attention to the volume action with each push into the tightening slope of the support line which is an indication of weakening supply & offers clues to the bullishness of the pattern.
3) The pattern confirms as a bullish continuation pattern if the action creates a new bullish breakout with a surge again from the bulls in both volume & price. The immediate upper resistance outlined by the falling wedge is the area traders look to see confirm the breakout. Typically the action will mimic the volatility & energy experienced with the Pole creation & volume considerations aid in recognizing further potential for the pattern. Often with a bullish breakout pattern the reaction in volume is ‘delayed’ & price pullbacks to ‘re-test’ are common.
Options for Trading the Falling Wedge as a bullish continuation pattern:
There are two methods of trading this pattern & it depends on your trading style.
Aggressive traders will find the falling wedge to be a little tricky to trade before a breakout actually occurs. However, as a bullish continuation trade the background support seen in the larger uptrend offers clues when combined with the tightening slope of the immediate lower support trendline created by the wedge. As the price action tightens in this area it is an indication of the lack of any real conviction from sellers. Aggressive entries long in this zone are available with the concept being the trend is on your side & the bulls are maintaining a ‘wall of support’ & again, closely monitor the reactive volume with each push into this support zone for clues.
This can be an accurate trade that usually has a great risk:reward ratio. Stop placement can be fairly tight right below support & can be adjusted upward accordingly. When price approaches the upper descending resistance line you should gauge the momentum: if you see that the momentum is strong stick to the position. However, if you see that resistance prevails, close the trade & take your profits to maximize the reward.
The aggressive trading method can highly increase the profit potential of any falling wedge. However, the trader needs to assess whether the ‘extra’ profits choosing the earlier entry offers a decent risk:reward over waiting for the breakout of the falling resistance line. Remember that as a trend continuation pattern traders want this consolidation falling wedge formation to be relatively brief. Two or 3 swings may turn into more and the ‘spread’ or range in prices offered to the Apex should aid trade consideration. Traders want to see momentum weakening as prices squeeze to the Apex.
Conservative traders will use the more traditional method & will enter a long trade once the upper falling resistance line has been broken &/or the new breakout has confirmed.
All traders should be prepared for re-trace activity or a reaction rally to test the newly created support level. An expansion of bullish volume can aid confirmation. False breakouts do happen & confirmation needed is always a traders’ choice. Several methods that apply here for either intrabar &/or close bar options offered in sequence: breakout above resistance price, retrace holds new support line, price clears breakout swing high price, price clears next swing high of wedge pattern, larger chart combination.
Stop placement considerations can be aggressively raised after the breakout of the price.
Measured Move Targets based on structure of Pole & the Bull Falling Wedge
Aggressive with Momentum & Volume: duplication of the original move or trader choice measurement of the Pole:
- Pole measure (added to) Apex or BreakOut price = target
- Pole measure = (Pole Tip price (minus) Pole Base price)
- Falling Wedge measure (added to) Apex or BreakOut price = target
- Falling Wedge measure = (swing high price of wedge (minus) swing low price of wedge)
Additional target considerations based on the Falling Wedge pattern itself are each swing high that created the pattern up to & including the re-test of the swing high of the pattern or Pole Tip price.
Examples: Falling Wedge as a bullish continuation pattern: