Next, we will learn a completely different type of chart pattern called Wedges.
What are Wedges?
Wedges are bullish and bearish reversal as well as continuation patterns which are formed by joining two trend lines which converge. It can be in the form of a rising wedge or a falling wedge. They are normally skewed triangles. The price action forms a cone that slopes down or up as the reaction highs and reaction lows converge. Rising wedge occurs when the price of the stock is rising over a time whereas falling wedge occurs when the price of the stock is falling over a time. This pattern can be drawn by using trend lines and connecting the peaks and the troughs. Once there is price breakout, there is a sharp movement of prices in either of the directions.
How to interpret this pattern?
The rising wedge chart pattern is formed when a market consolidates between two converging trend lines i.e. support and resistance lines. In order to form a rising wedge, both the support and resistance lines have to point upwards and the support line should be steeper than resistance.
The falling wedge chart pattern formed when a market consolidates between two converging trend lines i.e. support and resistance lines. In order to form a descending wedge, both the support and resistance lines have to point downwards and the resistance line should be steeper than the line of support.
Below is an example of Falling Wedge formed in daily chart of BSE Sensex:
Below is an example of Rising Wedge formed in weekly chart of Sundaram Finance ltd.:
Price target and Stop-loss:
The stop loss is usually placed below the back of the wedge. The profit target is set by measuring the height of the back of the wedge and extending that distance up from the trend line breakout.
The rising and falling wedges help us in predicting the reversals of the trends that help the traders in making appropriate trading decisions.