Falling Wedge Pattern and Rising Wedge Pattern with Turning Point Probability

In this chapter, we will show you how to combine statistical regularity and geometric regularity to trade with Wedge patterns. In Wedge patterns, the geometric regularity is recognized with the envelope triangle that encompasses the several fractal triangles inside with gradually contracting amplitudes (Figure 4.6-1).  This often indicates the decreasing volatility in the market. Trader often anticipates the explosive price movement after the decreasing volatility. Hence, trader tends to use the Wedge patterns for breakout trading. There are two different cases to trade with Wedge patterns. Firstly, the current price can be inside these patterns. Secondly, the current price can be outside these patterns with some distance. The trading tactics involved in these two cases are different. Hence, we will explain them one by one.

Figure 4.6-1: Conceptual drawing of Falling Wedge and Rising Wedge Pattern

Firstly, let us start with the case in which the current price stays inside these Wedge patterns. In this case, we would expect to use the outline of the wedge pattern as the breakout trading. Figure 4.6-2 shows the Falling Wedge pattern with the current price inside the pattern. To trade with breakout more accurately, we need to apply statistical regularity.

Figure 4.6-2: Falling Wedge pattern detected in EURUSD H4 timeframe

Firstly, we need to make sure that current trough is confirmed with sufficiently high probability. In this example, we can see that the trough has 82% probability in time dimension (Figure 4.6-3). This means that the price run in the same direction for the prolonged period. This gives us the clue for the turning point at this trough. If we do not confirm this, price can go down more probably. Hence, we have to wait longer for our breakout trading.

Figure 4.6-3: Falling Wedge pattern detected in EURUSD H4 timeframe

Once the trough is confirmed, then next thing we need to check is the distance between the trough and the breakout point. If we want to take the proactive action, we might have to guess the potential breakout point to measure the distance. If you can wait to see the actual breakout, then you can just measure the distance between actual breakout point and the trough (Figure 4.6-4). From the measured distance, we are looking for the fresh and young price movement. For example, we are looking for low probability at the breakout point. We need to make sure that there is a low chance that price will reverse because we are looking for breakout.

Figure 4.6-4: Falling Wedge pattern detected in EURUSD H4 timeframe

Summary for breakout trading by combining geometric regularity and statistical regularity for Falling Wedge pattern is like below:

1. Detect descending diagonal support and resistance with gradually decreasing volatility (Figure 4.6-1).
2. Check if the price is inside the Falling Wedge pattern.
3. Check if the latest trough provides the sufficient turning point probability either in price dimension or in time dimension.
4. Measure the distance between the breakout point and the trough. Make sure that the chance for reversal is low at the breakout point on the Falling Wedge pattern.

Now consider the example of rising wedge pattern. The trading logic is the same as before. Firstly, we will recognizing the Rising Wedge pattern by detecting ascending support and resistance with the gradually decreasing volatility. Then make sure that current price is inside the rising wedge pattern.

Figure 4.6-5: Falling Wedge pattern detected in EURUSD H4 timeframe

Next, we need to check some evidence to confirm the validity of current peak. For example, we need to make sure that latest peak provide sufficiently high chance for the turning point. We can check this using the turning point probability either in price dimension or in time dimension (Figure 4.6-6).

Figure 4.6-6: Falling Wedge pattern detected in EURUSD H4 timeframe

Next, we will measure the distance between breakout point and the latest peak. We need to make sure that the price movement at breakout point is fresh and young. Therefore, they can penetrate the bottom of the rising wedge pattern with higher power. The point is that the breakout point on the Rising Wedge pattern should not provide any potential for reversal because we are looking for breakout.

Figure 4.6-7: Falling Wedge pattern detected in EURUSD H4 timeframe

Summary for breakout trading by combining geometric regularity and statistical regularity for the Rising Wedge pattern is like below:

1. Detect ascending diagonal support and resistance with gradually decreasing volatility (Figure 4.6-1).
2. Check if the price is inside the rising wedge pattern.
3. Check if the latest peak provides the sufficient turning point probability either in price dimension or in time dimension.
4. Measure the distance between the breakout point and the peak. Make sure that the chance for reversal is low at the bottom of rising wedge pattern.

After you understood the examples for the Falling Wedge and Rising wedge patterns, you can tell that trading with Wedge patterns is nearly identical to turning point trading as in Support, Resistance, and Harmonic Pattern Trading. Now we will show you some bad example of breakout trading to aid your understanding. Figure 4.6-8 shows the Rising Wedge pattern with such an example. Many trader could anticipate the breakout when they detect the highest peak inside the Rising Wedge pattern. However, the distance between the breakout point and the peak nearly spans 90% probability in price dimension. As you can see, price can make the reversal rather than breakout. This is why we are looking for fresh and young movement at breakout.

Figure 4.6-8: Rising Wedge pattern detected in USDJPY H1 timeframe

There is a case that you believe that there is a chance for breakout no matter what. Although the distance to breakout is not too small, you might not want to miss the opportunity to trade. In this case, we will advise you to miss the first breakout on the Wedge pattern. However, you can make the entry at the second breakout point assuming the price is not moving inside the wedge pattern again. We know that when volatility runs out, price is likely to reverse. Hence, we do not have to rush for the first breakout point. It is better to wait the volatility to backup. Then we take the second breakout point as the safer entry. In doing so, the outline of the wedge pattern must support the price as shown in Figure 4.6-9.

Figure 4.6-9: Falling Wedge pattern detected in USDJPY H4 timeframe

So far, we have demonstrated the trading logic for Falling Wedge pattern and Rising Wedge pattern when the price is inside the pattern. However, some people use Wedge patterns when the price is outside them too. In this case, the trading strategy is more less the same with support and resistance trading. For example, the outline of wedge pattern will act as support and resistance. In fact, the outlines of Wedge patterns are just diagonal support and resistance as shown in Figure 4.6-1. For example, Figure 4.6-10 and Figure 4.6-11 shows the case when the Falling Wedge and Rising Wedge patterns act as support and resistance.

Figure 4.6-10: Rising Wedge pattern act as the resistance in EURUSD H1 timeframe

Figure 4.6-11: Falling Wedge pattern act as the support in USDJPY H1 timeframe

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