What Is a Falling Wedge Pattern?
The Falling Wedge is a bullish pattern that begins wide at the bottom and contracts as prices move lower and the trading range narrows. In contrast to symmetrical triangles, which have no definitive slope and no bullish or bearish bias, rising wedges definitely slope up and have a bearish bias. All falling wedges are bullish by nature.
Example of a Falling Wedge
What Does the Falling Wedge Signal?
The Falling Wedge pattern signals both a bullish continuation and bullish reversal pattern. Here are the 5 key points of a falling wedge:
- Prior Trend: In order to qualify as a reversal pattern, there must be a prior trend to reverse. The falling wedge usually forms over a 3-6 month period and can mark an intermediate or long-term trend reversal. Sometimes the current trend is totally contained within the falling wedge; other times the pattern will form after an extended advance.
- Lower Support Line: It takes at least two reaction lows to form the lower support line, ideally three. Each reaction low should be lower than the previous low.
- Contraction: The lower support line and upper resistance line converge as the pattern matures. The advances from the upper resistance line become shorter and shorter, which makes the drawdown unconvincing.
- Resistance Break: Bullish confirmation of the pattern does not come until the support line is broken in a convincing fashion. It is sometimes prudent to wait for a break of the previous reaction low. Once resistance is broken, there can sometimes be a reaction rally to test the newly found resistance turned support level.
- Volume: Ideally, volume will decline as prices drop lower and the wedge evolves. An expansion of volume on the resistance line break can be taken as bullish confirmation.
Trading a Falling Wedge Pattern
The falling wedge continuation pattern appears within a downtrend when price tends to consolidate, or trade in a more sideways fashion. Connecting the lower highs and lower lows will reveal the slight downward slant to the wedge pattern before price eventually rises, resulting in a falling wedge breakout to resume the larger uptrend.
Looking at the chart of Bitcoin Cash on the 4-hour time frame, we can see the falling wedge form after reaching a swing high from the start of the uptrend. So the start of the uptrend forms a trend line as well as the swing high of the initial uptrend move. From there, both these lines converge and consolidate the price into creating lower lows before its squeezed up and closes above the downtrend formed at the swing high. This pattern offered a perfect entry price at $250 along the bottom trend line, before breaking through $277 support and ending up all the way at $350. Wedge patterns are very explosive because the price is squeezed and accumulated for so long, getting themselves primed for a pump upwards.
Looking at the chart of the S&P on the 30-minute time frame we see a falling wedge formed with lower lows forming as the price squeezes between two trend lines. As the price can’t be squeezed anymore, it dips back under the lower trend line very briefly and offers a perfect buy target going long. From this buy signal, the S&P breaks out upwards out of this falling wedge and actually gaps up when it breaks out, indicating very bullish momentum for the Index.
Similarities Between the Rising and Falling Wedge
Rising Wedges and Falling Wedges are both wedge patterns marked by converging trend lines on a candlestick chart. The two trend lines are drawn to consolidate the price until it is squeezed out and breaks either up or down out of the wedge. Wedge shaped trend lines are considered useful indicators of a potential reversal, both in rising and falling wedge patterns.
Differences Between the Rising and Falling Wedge
Although Rising Wedges and Falling Wedges are both wedge patterns, they have a few differences. For starters, they are the exact opposite of each other. A Rising Wedge, hence the name, rises in price as the trend lines consolidate the asset upwards until eventually breaking out to the bottom side of the wedge. On the other hand, a falling wedge consolidates lower in price until the asset is eventually squeezed upwards breaking out through the topside of the wedge.
Limitations of Falling Wedges
The falling wedge pattern allows traders to get into a trending market after missing the initial move upwards. This offers a second chance for buyers to long the asset, however, a limitation of using a falling wedge in your technical analysis is that it requires additional confirmation using other technical indicators and oscillators.