Understand the Rising Wedge Pattern for Trading Reversals

What happens when a hiker reaches the top of a cliff? The trail becomes narrower. The hiker can go along the trail to explore the adjoining cliff on the loop, or they can begin their descent on the same path, or a different one. Something similar happens after a rising wedge chart pattern forms. The price channel in a bull run becomes narrower. It signals a potential bearish reversal. Learn how to identify the rising wedge pattern and techniques to trade it.

Rising Wedge Pattern Explained

A rising wedge is a multi-candlestick pattern that looks like, as the name suggests, a rising wedge. The pattern forms at the end of an uptrend. If you draw trendlines across the highs and lows of the candlesticks, they appear to narrow and may eventually intersect. The trendline connecting the highs is the resistance, while the one connecting the lows is the support. This means the price range continues to decrease, while the price is still rising.  Simultaneously, the volume decreases, indicating that bulls are getting weaker.

When the price breaks below the support line, it signals a potential bearish trend reversal. A good practice is to confirm the signal with other technical indicators before making a trading decision. 

Trading the Rising Wedge Pattern

Here’s an outline of how you can trade the rising wedge pattern.

Step 1: Recognise the Pattern

Look for the following:

• The market is in an uptrend. 
• The price is rise but the resistance and support lines are converging.
• The volume is decreasing, indicating that the bulls are losing control. 

Most trading platforms provide tools to effortlessly draw trendlines to determine resistance and support levels. You can use technical indicators, such as on-balance volume (OBV), volume-weighted average price (VWAP), Chaikin Money Flow (CMF), etc., to gauge the decline in the trading volume.

Step 2: Confirm the Reversal

To begin with, a reversal sets in when the candlesticks at (or after) the convergence of the trendlines start making new lows below the previous support line. The first one is called the breakdown candle, as the price begins to breakout below the support level from here. You can also verify potential reversals with the Relative Strength Index (RSI). An RSI value greater than 70 indicates an overbought market. This is an early sign of a potential bearish reversal.

If you want stronger confirmation, wait for the new support level to form. During a downtrend, the resistance trendline usually has a negative slope. The support could be straight or have a negative slope.

Check whether the volume accelerates as the price moves downwards. Increasing volume while the price declines also confirms a bearish reversal.

Step 3: Make Your Move

Traders holding a long position during the uptrend usually exit their trade at the convergence of the trendlines. Alternatively, you could use CFDs to trade the downward price move.

You could enter a short position:

• At the confluence of the trendlines, if other indicators confirm the bearish trend reversal.
• At a pullback, where bulls try to regain market control and test a new resistance level (or a broken support level).

Step 4: Place Risk Limits

Place a stop loss just above the breakdown candle or at the last high (the pullback level). You could place a trailing stop loss as the price continues to decline and lower resistance levels are set. These are intermediate swing highs during the downtrend.

You can use Fibonacci retracements to determine potential stop loss and take profit levels. Always consider market conditions to gain insights into broader sentiment, which may strengthen or limit the downtrend.

Step 5: Monitor Your Trades

The new trendlines form after at least three price peaks or troughs. Monitor your trades and watch out for any news events that could impact the price. This will help you exit or add to the position in a timely manner. 

Rising Wedge as a Trend Continuation Pattern

A rising wedge pattern can also form during a downtrend. In this case, the trendlines may also temporarily trend upwards. This indicates a consolidation phase before the broader downtrend resumes. This makes considering the broader timeframe crucial. Although you may trade with a shorter timeframe, knowing the broader market sentiment can help you make better informed trading decisions.

You can use trend strength indicators, such as the Average Directional Index (ADX), Ichimoku Cloud, and Moving Average Convergence Divergence (MACD), to determine the strength of the downtrend as well.

Falling Wedge Pattern

The falling wedge is the opposite of the rising wedge pattern. It appears in a downtrend and signals a bullish reversal. The trend reverses when the price breaks out above the resistance, after the convergence of the support and resistance trendlines.

You can follow the same steps to trade the falling wedge pattern. Use the resistance trendline and pullbacks to effectively place stop loss and take profit levels.

To Sum Up

• The rising wedge pattern is a bearish reversal.
• It forms after a sustained uptrend.
• It is marked by converging support and resistance trendlines.
• Confirming the trend before taking or exiting positions is crucial to making informed decisions.
• Occasionally, the rising wedge pattern acts as a trend continuation pattern for a bearish market.
• Using stop loss and take profit levels helps manage the risk associated with trading.

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