How to Trade Crypto Using Falling Wedge Pattern
Meaning of a Wedge
Wedges are price patterns that can be bullish or bearish (continuation or reversal of a trend). A wedge on a candlestick chart can be identified by the trend lines converging on a price chart. The wedges can either be descending (also known as falling wedges) or ascending (also known as rising wedges). Usually, intra-day wedges are difficult to identify as their price pattern is relatively weaker. Whereas, stronger wedge patterns can be seen over a monthly time frame.
What do wedges indicate?
Wedges indicate the slowing down of a price pattern. It depicts that the price now is consolidating as seen with the price moving at a slower pace. Support line rising faster than the resistance one indicates a rising wedge, whereas the resistance line rising faster than the support line indicates a falling wedge.
What does a falling wedge look like?
As you can see, the rate at which the price has been falling has reduced, indicating that consolidation has begun. The buyers are now fighting back the fall in price; however, they have not gained full control yet. Thus, a falling wedge often forms after a free fall in price, indicating a fast and impactful bearish move. Such a fall in the price can discourage new traders causing them to sell and also attract those traders who intend to short.
How to trade crypto using a Falling wedge
In a falling wedge, the bears are descending the price downwards. However, the bulls maintain horizontal support. This can be identified by ‘Lower Lows’ and ‘Lower Highs’ consolidating or converging, leading to a narrower price range. It is to be noted that as the wedge begins to form, the trading volume starts decreasing.
It is of prime importance to keep track of the trading volume. This is because as the wedge progresses and develops further, an increasing volume indicates a breakout.
There can be two possibilities from here on:
- Continuation Trend (Price continues to fall)
- Reversal Trend (Price begins to rise)
Let us look at what should be done in each of the above-mentioned scenarios using examples.
Continuation trend:
How is it formed?
The bears are pushing the price downwards as indicated by the downwards-sloping resistance trendline, however, the bulls are constantly maintaining horizontal support. This price pattern indicates that the falling trend has stopped, and the bulls have come into charge as seen by the decline in the rate of price fall.
What is the breakout?
Once the price has breached the horizontal support line, it indicates that the bears are in control yet again. This is an indicator of a further fall in price.
What position is to be taken?
Under the conservative approach, only once the support line has been breached and remains out of the support line even after the close, one can take a short position. There might be false breakouts and hence, it is prudent to take a position only if it is accompanied by strong trading volumes.
How to calculate the estimated range, target, and stop loss?
It is to be noted that the expected price range can be difficult to accurately predict and there is no such specific or reliable method for the same. However, the difference between the highest high and lowest low can be taken as an estimated range. And this range can be deducted from the breakout price to reach the estimated target.
Stop loss can be set up at a five percent or ten percent range above the breakout price. You can also take any other suitable percentage depending on your risk-return requirements for setting up stop losses. You can also top your trade up with trailing stop losses where the stop-loss price isn’t fixed but is set up as a percentage of current prices. This is very useful to lock in profits without taking much of a risk.
Reversal trend
How is it formed?
As discussed earlier that the price starts to fall at a lower rate, with the bulls maintaining the support line. However, the bulls have not yet taken full control as the price continues to fall. Accordingly, a falling wedge becomes identifiable.
What is the breakout?
Unlike the earlier example, the price in this case breaches the resistance line, indicating that the bulls have taken control from the bears. This is an indicator of a bullish trend.
What position is to be taken?
Only once the resistance line has been breached and remains out of the resistance line even after the close, one can take a long position. However, take a long position only after considering the trading volumes into the equation.
How to calculate the estimated range, target, and stop loss?
The difference between the highest high and lowest low can be taken as an estimated range. And this range is to be added to the breakout price to reach the estimated target.
Stop loss can be set up at a five percent, ten percent range, or any other suitable range below the breakout price.
Wedges and Triangles
Wedges and Triangles are both price pattern indicators and are often confused with each other. Let us understand the differences between both them.
Triangles are formed on Lower Highs and Higher Lows, depicted by the merging price pattern. Wedges, on the other hand, are formed on either ‘Higher Highs and Higher Lows’ or ‘Lower Highs and Lower Lows’.
Also, it is much easier to predict a breakout in a wedge as compared to a breakout in a triangle.
Other considerations
Wedges are considered to be a trader-favorite price pattern because once identified, it has the potential to give considerable returns. To accurately identify a falling wedge, you must also be aware of the prior trend, as it will determine which direction will be considered as a continuation or a reversal pattern. It is also important to set up trailing stop losses and read this along with other indicators.
As always, like with any other technical indicator, it is crucial to read the fundamentals.
Also, wedges being a common price pattern occur not only in crypto markets but also in other financial markets such as stocks, and commodities, among others.