What it means
To spot a wedge, a trader draws one line along the highs and another along the lows of a price chart. In a wedge, both lines slope up or both slope down, and they converge toward a point.
The shape resembles a narrowing slice of cheese, which gives the pattern its name. A rising wedge slopes upward, with the price making higher highs and higher lows, but each rise is smaller than the last.
Traders generally read this as a sign of weakening buying pressure and a possible fall. A falling wedge slopes downward and is generally read as a sign that selling pressure is fading and a rise may follow.
The signal comes when the price breaks out of the pattern. A rising wedge that breaks below its lower line, especially on higher trading volume, is taken as a bearish signal.
A falling wedge that breaks above its upper line is taken as a bullish one. A simple rule of thumb for a target is to measure the height of the wedge at its widest point and project it from the breakout level.
The target is only a rough guide and not a prediction, and traders use a stop-loss (an order that closes the trade at a chosen loss) in case the pattern fails. Many wedges do fail, so the pattern should be combined with other evidence.
The word also appears in other finance phrases, which can cause confusion. A tax wedge is the difference between what an employer pays for labour and what the worker takes home, and a wedge issue is a political topic that divides voters.
In this entry the meaning is the chart pattern used in technical analysis.
In practice
Real-world examples.
Example
A trader sees a share climbing in smaller and smaller steps, with volume falling. She draws two upward sloping lines that converge and recognises a rising wedge. When the price falls through the lower line, she sells her holding.
Example
A currency analyst notes that the euro has been falling against the dollar in a narrowing downward channel. The pattern is a falling wedge, and the analyst waits for the price to break above the upper line. After the breakout, the analyst recommends reducing hedges.
Example
A portfolio manager looks at the chart of a commodity index and sees a possible wedge, but the lines are not clear. She decides not to trade on it. She notes that a pattern that needs a lot of imagination is rarely reliable.
Formula
Calculation
Approximate target after a rising wedge breakdown = Breakout price - Wedge height at its widest point
Suppose a share rises inside a rising wedge, and at the widest part of the pattern the upper line is at $58 and the lower line is at $50. The wedge height is 58 - 50 = $8. The price then breaks below the lower line at $50. The approximate target is 50 - 8 = $42. A trader who sold short at $50 might place a stop-loss at $53, risking $3 for a possible gain of $8.Case study
Seen in the real world.
Halden Trading Desk is an illustrative, fictional proprietary trading team that uses charts alongside company analysis. A junior trader spotted a rising wedge on a mid-sized retailer's shares, which had risen from $40 to $58 in smaller steps over three months.
The team agreed to act only if the price broke the lower line on strong volume. When the shares fell through $50, they sold a small position with a stop-loss at $53, and the price dropped to $43 within two weeks.
In this illustrative story the team recorded that the pattern worked, but also kept a note of three earlier wedges that failed. The lesson is that a wedge is a probability tool, and success comes from limiting losses when it does not work.
Watch out
Common mistakes.
- Treating every narrowing price range as a wedge, when the two lines must slope the same way and the pattern should have several touches on each line.
- Trading before the breakout, when the price can continue inside the wedge or break in the opposite direction.
- Ignoring risk control, since wedges fail often and trades need a stop-loss.
Questions
People also ask.
Is a rising wedge always bearish?
Not always, but it is generally read as a bearish pattern because buying pressure is weakening, and it needs a breakdown to confirm it.
How does a wedge differ from a triangle?
In a wedge, both lines slope in the same direction, while in a symmetrical triangle one line slopes up and the other slopes down.
Does volume matter?
Yes, falling volume as the wedge forms and rising volume at the breakout are often taken as signs that the signal is more reliable.
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