What is a wedge?
A wedge pattern develops when the highs and lows of a particular stock start to converge. As the pattern begins to develop, you can draw trend lines at the top and bottom of the pattern. You will notice the two lines forming what resembles a wedge.
How many different wedge patterns are there?
There are three main wedge patterns that you need to learn about. The ascending wedge, descending wedge, and vertical/symmetrical wedge. Wedges are great instruments to determine price reversal or continuation. There are several things that you can do to determine whether the wedge will be bullish (continuation).
How do I determine if the wedge will be bullish?
In trading, the price movement goes through various stages before continuing or reversing. For this article, we'll talk about the continuation pattern. A wedge pattern must meet specific criteria to be a successful bullish pattern. We will describe the requirements in the following paragraphs.
What is a continuation pattern?
A continuation pattern is when a stock price continues moving upwards. Stock prices never move in a straight line up or down. There are moments in a stock's price upward or downward momentum when it needs to take a break. Traders call this period of rest consolidation.
What is consolidation?
Consolidation occurs when a stock's price stops its direction up or down and begins trading sideways. When the stock is consolidating, and the wedge starts to form, there must be a steady decrease in volume.
What is volume and why is it important?
Volume is the number of shares exchanged during a determined time frame. For example, if a trader uses the 1 day 1 minute time frame, the volume will be the number of shares traded per minute. Volume needs to increase as the price breaks out of the wedge pattern to continue its upward momentum. Without the increase in volume, the breakout will likely fail.
What criteria are key to success?
As the wedge is developing, we can look for several criteria to determine whether the price will break to the upside for continuation. During this consolidation stage (wedge formation), the volume needs to be decreasing as the price's high and lows converge closer to each other. The decrease in volume will keep the consolidation period intact until the price has no more room to move and needs to pick a direction. In this particular case, we want the price to break the upper trendline. If the price breaks the upper trendline with an increase in volume, we can consider it a successful breakout most of the time.
The following illustration shows a successful symmetrical wedge pattern.
Illustration provided by Thinkorswim.
Disclaimer: Results may not be typical and may vary from person to person. Making money trading stocks takes time, dedication, and hard work. There are inherent risks involved with investing in the stock market, including the loss of your investment. Past performance in the market is not indicative of future results. Any investment is at your own risk!