Quite often, beginners jump into the world of trading without proper knowledge of it. After numerous losses and costly mistakes, they move to the next level of professional trading and begin to apply technical analysis. What is it about? Technical analysis can be described as an attempt to predict a chart pattern. In other words, we study price behavior in the past to forecast its movement in the future. For technical analysis to be highly effective, various tools should be used, including indicators, chart patterns, etc. Today, we are going to talk about one of the most useful patterns in technical analysis – the falling wedge pattern.

Read more about different patterns of technical analysis in the dedicated section on the InstaForex website.

What is a Falling Wedge?

A wedge is a price structure in the shape of a cone which connects the respective highs or lows that converge in a narrow zone.

The falling wedge pattern is formed when the price fluctuates between the two converging downward trend* lines. Since the falling wedge is a reversal pattern, it is hard to predict the exact direction of the price until the pattern is fully formed.

In most cases, the falling wedge indicates the beginning of a bullish trend (the price goes up). However, it may also signal a reversal or continuation of the trend.

Often, these multiple meanings of the falling wedge confuse traders. Therefore, analyzing market conditions can help you determine the real nature of the pattern. First of all, the direction of the trend at the moment when the wedge appears can tell us a lot. Thus, the falling wedge is considered a continuation pattern if it is formed during an uptrend. On the other hand, it is a reversal pattern when it occurs during a downtrend.

*A trend is a leading direction of the price.

In stock market trading, wedge patterns are usually analyzed on higher time frames such as H1 and above.

Elements and Features of the Falling Wedge Pattern

The process of formation and completion of the falling wedge pattern consists of several elements:

  1. It is most often preceded by a downtrend.
  2. The upper resistance line is formed by two or three contact points. Each of these points must be located lower than the previous one.
  3. The lower support line should also be formed by two or more contact points. The pattern is being formed correctly if the slope made from support and resistance lines is narrowing.
  4. When the price crosses the resistance (or support) line, the pattern has been completed. The line that converges with the price is considered a target for future price movement.
  5. One of the main factors for the pattern formation is trading volume. As a rule, trading volume should increase at the end of the pattern where the lines cross. Otherwise, the pattern is considered to be false.

It is essential for a technical analyst to promptly detect a falling wedge on the chart as this pattern is very similar to other structures. Therefore, patience is the main helper here. Note that it is crucial to wait until the pattern is fully formed so that you can check the further direction of the price and trading volume.

Pros and Cons

Pros:

  • This pattern is very common when trading in the foreign exchange and stock markets
  • Thanks to the falling wedge, investors can still gain profit even though they have missed the start of the trend movement
  • This pattern is one of the easiest to set limit and stop orders as well as to find entry points
  • The falling wedge pattern is an ideal combination of risk and profit factors

Cons:

  • Novice traders are often confused by the pattern’s ambiguity
  • When trading this pattern, you may need additional confirmation from other market indicators and oscillators
  • Oftentimes, the falling wedge is identified incorrectly
  • The pattern can indicate both a reversal and continuation of the trend

Conclusion

The professional language of trading may sometimes scare off beginning traders. By giving you an example of one of the trading slang terms, we proved that there is often a simple chart pattern behind each complicated expression. We hope that after learning about the falling wedge pattern, you might want to delve into the world of technical tools. If you are ready to start now, open a demo account on the InstaForex website. As soon as you appreciate the advantages of the new chart pattern and would like to use it in practice, you are welcome to open a live trading account with InstaForex.