What Is the Falling Wedge Pattern and How to Trade It
By Stelian Olar, Updated on: Feb 08 2024.
The falling wedge pattern, also known as the descending wedge or downward wedge pattern, is a distinct chart pattern formation marked by converging trend lines bounding prices in a downward slope. This decending wedge or declining wedge pattern indicates market indecision, where bears are winning but bulls stage mini-comebacks giving rise to a wedge formation.
The falling wedge pattern meaning is that it often resolves bullishly, making it a pattern of high interest for traders.
So what exactly does this falling wedge or downward wedge chart pattern look like and how might you aim trading the falling wedge?
By understanding the criteria that defines this chart pattern as well as the psychology behind its typical bullish bias, you’ll be better equipped to spot falling wedge opportunities and utilize them in your trading.
This guide will cover everything you need to know about falling wedges including:
- The visual criteria that characterize this distinct price action pattern
- Why the descending wedge tends to breakout upwards?
- Is the falling wedge bullish or bearish?
- Strategies to trade the pattern through identifying optimal entries, stop losses, and profit-taking levels
Whether you’re an experienced technical trader well-versed in the wedge formation or just starting out, this primer aims to make the falling wedge pattern clear.
Read on to learn how to identify the falling wedge and use them effectively to inform your market decisions.
What is the Logic Behind the Falling Wedge Pattern
The falling wedge is considered a bullish reversal pattern in technical analysis, signaling a potential trend reversal. It's defined by two converging trendlines - a descending resistance line connecting a series of lower swing highs, and an ascending support line connecting higher lows. This forms a descending wedge pattern shaped like a funnel or a wedge tapering down.
As this down wedge pattern takes shape over a period of time, we get clues into the psychology driving the market:
- The descending upper resistance line reflects the persistence of selling pressure.
- However, the ascending support line indicates buyers are gradually becoming more active at higher levels on pullbacks.
This suggests sellers are losing conviction while buyer interest continues to resurge. What was once a strongly bearish market has now shifted towards more balance between bulls and bears. Typically, the falling wedge will eventually resolve upwards from this equilibrium as buyers gain control - hence it is considered a bullish falling wedge.
So while similar in appearance to a descending triangle, the key difference is the rising support line - reflecting building buying pressure which tends to fuel an eventual upside breakout. This underlying logic is what makes understanding and trading falling wedge patterns so valuable in technical analysis.
What is the Target of the Descending Wedge Pattern
Since the falling wedge is a bullish pattern, traders want to capitalize when the pattern eventually breaks out upwards.
But what price level should you set as your profit target?
A standard approach is to measure the vertical height of the entire descending wedge pattern from the initial high at the start to the lows of the base then add that height distance projected upwards from the eventual breakout point once the pattern triggers.
So for example, if a falling wedge lasts 3 months forming between a $50 initial peak down to $40 at the lows, the height would be $10. If the pattern then breaks upwards from $45, the profit target would be $45 plus the $10 height - which comes out to $55.
According to some research, the falling wedge pattern probability of meeting the price target for upside breakouts is 62%.
The logic is that the vertical measure captures the entire preceding down move counteracted by built-up bullish energy. As that energy releases, it powers upside down by roughly that amount.
Of course, falling wedge breakout targets can be exceeded as well in strongly trending markets but this method aims to capture the high probability breakout move. Tuning your strategy to the typical measured target can maximize your reward in playing these constructive falling wedge pattern setups.
Descending Wedge Pattern Types
While all falling wedges have the same general shape, there are some variations when it comes to the specific type of descending wedge pattern that forms. The two main types are broadening versus narrowing wedges.
Descending Broadening Wedge Pattern
A descending broadening wedge pattern is when the distance between the upper resistance line and the lower support line expands over time. This reflects increasing volatility and uncertainty in the market. The slope of the lines is also more gradual with the broadening wedge pattern.
Narrowing Falling Pattern
Meanwhile in a narrowing falling wedge, the upper and lower lines contract and converge towards an apex, like a symmetrical triangle. This shows decreasing volatility as the market equilibrium tightens.
Falling Broadening Wedge Pattern
Falling wedges can also differ based on the prevailing trend when they emerge:
- Falling wedge pattern in a downtrend - forms within a broader downtrend as a continuation pattern signaling more downside before an eventual breakout
- Falling wedge pattern in an uptrend - emerges within a larger uptrend as a pause/pullback before the upside resumes
Being aware of these ascending vs descending wedge differences and also related patterns like the falling broadening wedge pattern and the symmetrical triangle can help you better recognize falling wedges.
Training your eye to spot descending broadening trends in those boundary lines is key to consistently identifying quality setups. If you want to trade falling wedges and other chart patterns, check out FP Markets forex broker which provides excellent charting tools and competitive spreads.
Falling and Rising Wedge - Know the Differences
While both have wedge shapes, falling wedges and rising wedges have key distinctions traders should understand.
The falling wedge is considered bullish, with a downward slant bounded by a descending resistance line but a rising support line which reflects selling pressure easing up faster than buying pressure. The pattern typically breaks out upwards.
Meanwhile, rising wedge patterns slope upwards, bound by a rising resistance line and rising support line where the support is rising faster. This reflects buying pressure fading faster than selling pressure.
Rising wedges are usually seen as bearish and more prone to break downwards.
So while the falling and rising wedge pattern may appear similar at first glance, remembering just a few core differences can help you distinguish:
- The direction of slope - falling is down, rising is up
- Bullish vs bearish bias - falling = bullish, rising = bearish
- The slope of boundaries - falling has descending resistance but rising support, rising has rising resistance and faster-rising support
Keeping these key rising versus falling wedge contrasts in mind will help you spot these patterns early and position accordingly based on their expected bullish or bearish personalities going forward.
Advantages and Limitations of the Downward Wedge Pattern
Let's examine the key pros and cons:
- Clear visual patterns easy to spot on charts
- Defined trade entry signal when upwards break of falling wedge resistance occurs
- Stop loss neatly under recent wedge support
- Defined upside price target based on previous pattern height
- Descending expanding wedge and broadening patterns may break down more often
- False breakout moves can trigger stops prematurely
- Existing strong trends may overwhelm fledgling wedge reversals
- The ascending broadening wedge can be confused with valid falling wedges
- Discerning between descending wedge bullish or bearish signals takes time
Overall while not perfect, pairing falling wedge bullish signals with sound risk management kicks trading odds in your favor. Awareness of both the pattern's promise and drawbacks leads to best application.
How to Trade Downward Wedges - Enhance Your Trading Strategy
Now that we've covered what falling wedges are and the logic behind them, let's discuss how to actually trade them for profit. By adding descending wedge patterns to your trading strategy, you can enhance results.
Here are tips for trading falling wedges:
- Wait for a confirmed breakout - Place buy-stop orders just above wedge resistance to trigger when an upside breakout happens
- Set initial stop under recent swing lows within the wedge down pattern to contain losses if it fails
- Trail stops higher beneath each minor pullback to lock in more profits in a strong upside move
- Book partial profits at the typical 1x wedge measured move target
- Hold remaining position to let winners ride in strongly trending scenarios
Trading rules are simple: Look to buy the first sign of bullish price breaks, use protective stops, and take partial profits early while allowing flexibility to hold runners.
Adding awareness of falling wedge pattern breakout signals and having a game plan to trade them puts you in a position to profit when these constructive chart patterns emerge.
Ready to start identifying and trading falling wedge patterns for yourself?
The best way to learn is by practicing on demo charts.