Introduction on Falling Wedge Bullish Reversal Pattern

Day-traders wouldn’t exist if it wasn’t for charts, graphs, and patterns. Technical analysis is the key used by intraday traders and most short-term traders to analyze price movements. Technical analysis is a method to forecast the price directions by primarily studying historical prices and volumes.

These parameters form the technical charts and analysts believe that history tends to repeat itself. Certain patterns formed in the past are most likely to result in similar results time and again. While technical analysis is beyond charting, it always considers price trends. Investor behaviours tend to repeat and hence recognizable and predictable price patterns are formed in a chart. In this article, you will know about a bullish chart pattern called the falling wedge pattern in detail.

Falling Wedge Pattern

A chart pattern formed by converging two trend lines is called a wedge pattern. Wedges created after a downtrend is known as the falling wedge pattern. Wedge patterns in a technical analysis indicate a trend reversal as well as continuity. In line with that, the falling wedge pattern indicates whether the prices will keep falling or it will reverse the course of their downward momentum, depending on its location. Irrespective of the indicator of reversal or continuation, the falling wedge pattern is considered a bullish pattern.

Technically, a falling wedge pattern is formed when two converging trend lines of a consistently falling stock are joined. It starts wide at the top and converges as the price moves lower, forming a cone as the lower highs and lower lows converge. The bullish bias is realized as soon as a resistance breakout occurs.

A rising wedge pattern is the opposite of a falling wedge pattern that is formed by two converging trend lines when the security prices have been rising for a long time. A rising wedge pattern is considered a bearish pattern in terms of technical analysis. Buyers join the market before the convergence of the lines resulting in low momentum in declining prices. This results in the price breakout from the upper trend line.

The prices of a security falling over time forms a wedge pattern as the trend makes its final downward move. The pattern is formed by drawing the trend lines from above the highs and below the lows on the price chart. These trend lines converge as the prices lose downward impulse and buyers start taking long positions slowing the rate of price decline.

Unlike the triangle chart pattern where the direction of the breakout is unpredictable, in the falling wedge pattern prices may breakout above the upper trend line before the trend lines converge to complete the wedge. This breakout event is expected to reverse the price movement and trend higher.

How does Falling Wedge Pattern Work?

Wedge patterns are a good indicator of both a continuation of the trend or a trend reversal. This indication depends on the location of the wedges. A falling wedge may indicate a security continuing to keep declining prices or a bullish reversal. The continuation and reversal are concluded in two scenarios:

1. Falling Wedges in Uptrend: A falling wedge in an uptrend signals the continuation of an uptrend. It means the prices are making lower highs and lower lows compared to the previous price fluctuations.

   It provides new traders with an opportunity to buy the security and the existing holders to average their positions in the market.

2. Falling Wedges in Downtrend: A falling wedge in a downtrend signals a bullish reversal. It depicts that the prices are making lower highs and lower lows compared to the previous price fluctuations. It indicates traders take long positions in the market.

   Traders using a falling wedge pattern should buy as soon as the prices break above the upper converging trend line with a stop loss at the bottom of the falling wedge. Typically, the price targets are equal to the height of the back of the wedge.

How do you identify a falling wedge pattern?

The falling wedge pattern is used to locate a decreased momentum in the downside direction and alert the technical analysts of a prospective reversal or the continuation of the pattern. However, to qualify as a falling wedge pattern there are a few technical parameters:

1. Previous trends: Typically, a falling wedge is formed after a prolonged downtrend of at least three months. The pattern is usually formed over three to six months. It marks the final low after the continued downtrend.

2. Resistance: It is considered good to have at least two reaction highs to form the upper resistance. The pattern makes lower highs and forms the upper resistance line.

3. Support: Similar to the upper resistance line, at least two reaction lows are required to form the lower support trend line. The pattern makes lower lows and forms the lower support line.

4. Convergence: As the pattern becomes prominent, the upper resistance and the lower support lines converge to form the shape of a cone. While the lower highs are deeper, lower lows are comparatively shallower. This forms an upper resistance slope more negative than the lower support slope. Shallow lows indicate a decline in selling pressure.

5. Breakout: To confirm the bullish bias of a falling wedge, the resistance line needs to break even convincingly. It is important to note that once resistance is broken, there might be a correction cycle to test the newly formed support level.

6. Volume: It is a salient feature to confirm a falling wedge pattern. The expansion in trading volume increases the conviction of the traders and analysts. It also makes it less vulnerable to failure.

   The falling wedge pattern is considered to be one of the most difficult charts to identify and take action from for technical analysts and traders.

Importance of a falling wedge pattern

A falling wedge pattern is a bullish pattern in technical analysis that signals the loss of momentum in the downtrend. It indicates either the continuation or reversal of the ongoing trend.

It prominently signals the end of the correction or consolidation phase. The buyers exploit the consolidation of prices to reform the new buying opportunities so that the traders can defeat the bears and push the prices higher.

Wedge vs. Triangle Charts

Wedges and triangles are technical indicators formed by converging the support and resistance trend lines. While they may have similar characteristics, both of them are different.

The trend line connecting the support and resistance levels in a triangle chart either slope in opposite directions or one of the lines remain horizontal. This means the support level slopes upward and the resistance line slopes downward in a triangle chart.

The trend lines converging the support and resistance level in a wedge pattern slope in the same direction, however, they may differ in magnitude.

Essentially in wedge patterns, the breakout direction is predictable but it is difficult to know the breakout direction in the case of a triangle pattern. It is suggested to cover positions while trading with triangle charts as the breakout can occur in any direction.