Strategy 6: Rising Wedge Pattern

 The rising wedge is a popular reversal pattern that is predictive in nature and can give traders a clue to the direction and distance of the next price move.

Rising wedges appear regularly in the financial markets and traders gravitate towards the pattern because of its simplicity in identification and application

WHAT IS A RISING WEDGE PATTERN?

The forex rising wedge (also known as the ascending wedge) pattern is a powerful consolidation price pattern formed when price is bound between two rising trend lines. It is considered a bearish chart formation which can indicate both reversal and continuation patterns – depending on location and trend bias. Regardless of where the rising wedge appears, traders should always maintain the guideline that this pattern is inherently bearish in nature (see image below).

HOW TO IDENTIFY A RISING WEDGE PATTERN

The rising wedge pattern is interpreted as both a bearish continuation and bearish reversal pattern which gives rise to some confusion in the identification of the pattern. Both scenarios contain a different set of observation dynamics which must be taken into consideration.

Continuation Pattern:

1. Established downtrend
2. Rising wedge consolidation formation
3. Linking higher highs and lower lows using a trend line assembling towards a narrowing point
4. Confirm divergence between price and volume using volume function - MACD may also be used
5. Overbought signal can be confirmed by other technical tools like oscillators (RSI)
6. Look for break below support for short entry

Reversal Pattern:

1. Established uptrend
2. Rising wedge consolidation formation
3. Linking higher highs and lower lows using a trend line assembling towards a narrowing point
4. Confirm divergence between price and volume using volume function - MACD may also be used
5. Overbought signal can be confirmed by other technical tools like oscillators
6. Look for break below support for short entry

HOW TO TRADE THE RISING WEDGE PATTERN

The chart above shows a rising wedge ‘continuation’ pattern after a determined downtrend. The rising wedge is outlined by the blue dashed lines showing diminishing bull strength in the uptrend. Confirmation of the uptrend waning in strength can be seen using the volume tool on the chart which depicts fading volume in concurrence with the ascending price in the market. This is known as divergence, showing that the upward movement is coming to an end.

The entry point (labelled) occurs once the trend support line of the rising wedge has been breached. There are two common methods of entry:

1. Wait for a candle close below the support trend line before entry
2. Enter into the short position as soon as the price breaks the support line, regardless of the candle close

The stop level as highlighted on the chart is elected from the high point of the rising wedge located on the resistance trend line. This identification point makes it relatively simple to locate the stop level for novice traders. The limit in this example was taken from the previous swing low giving this trade an extremely positive risk-reward ratio.

Strategy 5: HEAD AND SHOULDERS PATTERN

 

key action points when identifying this pattern:

1. Identify the overall market trend using price action and technical indicators (preceding uptrend)
2. Isolate the Head and Shoulders chart construction
3. The distance between the ‘Head’ and ‘Shoulders’ should be as close to equidistant as possible
4. Delineate the neckline at the low point between both ‘shoulders’ – preferably horizontal but not obligatory

The Head and Shoulders chart pattern is a price reversal pattern that helps traders identify when a reversal may be underway after a trend has exhausted itself. This reversal signals the end of an uptrend. The Head and Shoulders pattern has a distinctive appearance resembling its namesake which includes a distinct ‘left shoulder’, ‘head’, ‘right shoulder’ and ‘neckline’ formation.

WHAT IS THE INVERSE HEAD AND SHOULDERS PATTERN?

The Inverse Head and Shoulders (informally known as the 'Reverse Head and Shoulders pattern) resembles the same structure as the standard foration but reversed. The Inverse Head and Shoulders is observable in a downtrend (see image below) and indicates a reversal of a downtrend as higher lows are created.

There is a general rule of thumb to designate stop and limit levels. Taking the high point off the ‘right shoulder’ will specify the stop level whilst the vertical distance between the neckline and high of the ‘head’ will approximate the limit distance – 1832.8 pips in this case. The risk-reward ratio on this trade is roughly 1:1.2 which is still within the DailyFX recommended risk management parameters.