Trading the Wedge

Trading the Wedge

By Toni Hansen

Description: This is a specific type of triangle that has a noticeable slant to it with higher highs and higher lows for an ascending or rising wedge or lower highs and lower lows for a descending or falling wedge. The characteristics detailed below apply to a rising wedge for a short setup, but can be easily reversed for a falling wedge buy setup. The wedge formation is typically a reversal pattern, meaning that the trend within the wedge itself will reverse when the trend breaks, although it can serve as a continuation pattern if the trend is new. For the purposes here, however, it will be discussed in terms of a reversal, with a rising wedge viewed in terms of a break lower and a falling wedge breaking higher.

Criteria: Uptrend with higher highs that break by a lesser degree than before, while the higher lows are still separated by greater differences in price, creating a triangle that slants higher when the upper and lower trend lines are drawn.

Entry: When the lower trend line breaks. Alternate entries are when the last uptrend within the wedge breaks lower or drop down to a smaller time frame and watch for a 2T or Avalanche and utilize those entry criteria.

Stop: Over the highs of the rising wedge, or over the highs of the base on an Avalanche formation if the wedge begins to hug the lower trend line after pulling off the highs before breaking lower.

Target: The target on the wedge depends on where it occurs in the larger trend. The main support levels in a rising wedge will be at each of the pivot lows within the wedge itself. When a downtrend is new and the rising wedge is a continuation pattern, then an equal move out of the wedge as compared to the drop into the wedge is the larger target.




Ideal 5 Tech Tools Traits:

Pace: Above average pace heading into the start of the wedge, followed by a slower trend for the wedge itself. In the case of a rising wedge this means a strong drop lower, followed by a slower rising wedge. Within the wedge itself it helps if the pace slows on the upside as the wedge nears completion. The best circumstance is when the security pulls strongly back into the lower trend channel from the wedge and then hugs that support just prior to breaking down out of the rising wedge. The reverse applies to a falling wedge.

Volume: The volume will ideally increase heading into the start of a rising wedge formation and then decline as the wedge progresses. If the wedge hugs the lower trend line from the move higher just before breaking, then that volume should be the lightest of the entire wedge.

Correction Periods: Higher changes for success when the highs of the wedge correspond to a correction period or the trigger for the wedge corresponds to a correction period.

Support/Resistance: In a rising wedge, it is good to have strong upside resistance, followed by a pullback to the lower trend line. The security then has higher odds for a strong follow through when it hugs that lower trend support just prior to breaking down. A lack of significant support, such as a previous low or congestion zone that would hit right away will also increase the odds for a successful move.

Trend Placement/Trend Development: A rising wedge is common in a downtrend as a correction within that larger bear move. It can also be located at highs as the last move up within a larger uptrend before a larger correction off highs takes place. A rising wedge is higher risk as a short setup when it occurs at the beginning of a new uptrend, since momentum can be building and any break lower at that point out of the rising wedge can easily be just a small base before the wedge then breaks to new highs.

Rising Wedge Examples

Example #1: Occidental Pet. Corp. (OXY) Rising Wedge – A Short Setup




Pros on Rising Wedge in OXY:

1. OXY made only slightly higher highs, but significantly higher lows as it rose, creating a narrowing channel for the wedge formation.

2. After taking only 15 minutes to drop off the 10:30 ET highs, it then took three hours to return to that level.

3. The prices from the start of the 10:30 ET decline created a strong price resistance level.

4. Volume was the strongest at the start of the rising wedge and then declined throughout most of the upside move.

5. The rising wedge had three waves of upside within it, which is typical of an exhausted uptrend, making is easier for the stock to form a larger correction on a pullback following the third waves of buying that took place coming out of 13:00 ET.

6. The third move higher was much choppier than the prior two and began to hug the lower trend line and test it repeatedly while starting to avoid the upper end of the channel.

7. Volume increased as the wedge broke lower, providing confirmation to the setup.

Cons on Rising Wedge in OXY:

1. The move out of the rising wedge did not correspond directly to any correction period even though the 14:00 ET one was approaching.

2. OXY is a more volatile stock with a lot of overlap from bar to bar which created a somewhat larger stop since a trader could not drop down and short an Avalanche on a smaller time frame as the trigger to the wedge breakdown.

Example #2: ES Rising Wedge Pattern Intraday – A Short Setup




Pros on 2 Minute Rising Wedge in the ES:

1. The large momentum heading into the wedge was on the downside. It then took 90 minutes to just regain the losses from the gap and immediate selling out of the open.

2. The rising wedge had three waves of buying in it, which is typical for a trend development, creating an exhausted trend before the wedge broke lower.

3. The volume decline throughout the rising wedge and did not increase at all coming out of the last pullback into 10:45 ET, indicating that despite the strong upside, there were not a lot of determined buyers present.

4. The second high in the wedge was only slightly higher than the first and the third high was comparable to the second, whereas each low was significantly higher than the last.

5. The final pivot high within the wedge took place heading into the 11:00 ET correction period.

6. As the wedge hugged the lower trend line leading into the second setup, the volume declined even further, despite the correction to the selling into 11:00.

7. The pace of the moves out of 11:00 and then along the lower trend line indicated a bearish bias since the upside was much weaker than the downside.

Cons on 2 Minute Rising Wedge in the ES:

1. The momentum within the wedge did not slow on the upside until the stock had already traded under the lower trend line, so those taking a trend line break as an entry would have had to have sat on the position for awhile before the stronger selling continued.

2. Volume did not increase much on the selling coming out of the wedge to provide strong confirmation for the breakdown.