In the contemporary marketplace, technical analysis is the preferred methodology for countless forex, futures, debt and equities traders. By utilising a vast array of indicators and tools, market technicians attempt to secure profitability by studying price action. Among the most popular devices implemented in technical analysis are chart patterns.
A chart pattern is a visually discernible formation in price. Patterns offer insight into past and present market states, and are viewed as being valuable for projecting future price behaviour. For technical traders, chart patterns are used to craft trade-related decisions, such as determining market entry/exit points or in active position management. Several of the most popular formations are channels, Dojis, engulfing patterns and wedges.
What Is An Ascending Wedge?
An ascending wedge, also known as a "rising wedge," is a bearish chart pattern used to identify market reversals. This type of formation consists of three distinct elements:
- Upper Trendline: The upper trendline connects a security's periodic highs and represents the top of the ascending wedge. As the upper trendline rises, it connects a series of higher highs.
- Lower Trendline: The lower trendline connects a security's periodic lows and represents the bottom of the pattern. Within the context of the ascending wedge, the lower trendline connects a series of higher lows as it rises.
- Apex: The Merriam-Webster dictionary defines apex as being "the uppermost point" or "the narrowed or pointed end." As it pertains to the ascending wedge, apex is best thought of as the latter.
The ascending wedge develops when the upper trendline and lower trendline converge at the apex while adhering to an upward trajectory. Visually, the ascending wedge's upper and lower trendlines have positive slopes, suggesting that price is rising as time goes on. Also, as each trendline rises, the distance or "range" between the two decreases. The result is the appearance of an elongated, upward-tilted triangle.
Trading The Ascending Wedge
The ascending wedge tells the trader two things: price is becoming compressed and the periodic rally may be approaching exhaustion. Given this information, the chances of a market reversing its course are significant.
To capitalise on the forthcoming bearish price action suggested by an ascending wedge, a short trade is warranted. Before entering the trade, the pattern's components determine market entry and exit:
- Market Entry: In order to open a new short position, sell orders are placed beneath the lower trendline within a close proximity to the apex.
- Profit Target: Profit targets may vary according to each trader's resources and objectives. However, profit targets are commonly aligned with the various periodic lows that comprise the lower trendline.
- Stop Loss: Once again, stop loss location may vary with respect to strategy. Nonetheless, a standard stop out point is above the upper trendline.
The ultimate goal of trading the ascending wedge is to garner profits through catching a bearish move in pricing. When traded consistently within the context of a comprehensive trading plan, the pattern can help generate marketshare.
Watch For False Signals
Of course, no chart pattern, tool or indicator is infallible. The ascending wedge pattern does have a tendency to produce false sell signals. There are many reasons for this, namely sudden and extreme volatility, lagging participation or extended market consolidation. In order to avoid falling prey to false signals, traders look for several queues to confirm validity of the pattern:
Volume is an important element to watch when trading the ascending wedge. As the wedge's upper and lower trend lines converge, it is ideal if trading volumes are decreasing. Accordingly, as price rises within the wedge, it is best if traded volumes are falling; this occurrence suggests a lack of new bids and pending bullish exhaustion.
Typically, an ascending wedge forms in the aftermath of a significant market sell off. If valid, the pattern gives the trader an opportunity to go short and join the prevailing bearish trend.
In bearish trending markets, Fibonacci retracement levels are used to determine if the broader market sell-off is still technically valid. Generally, as long as the ascending wedge develops beneath the sell-off's 38% or 50% Fibonacci retracement levels, a short trade is deemed appropriate.
Myriad other technical indicators may be used to compliment the ascending wedge. Several of the most common are classified as momentum oscillators such as Stochastics or the Relative Strength Index (RSI).
Pros And Cons Of Ascending Wedge
Like all technical tools, chart patterns have a specific set of advantages and disadvantages. The ascending wedge is no different, as its unique functionality affords a collection of pros and cons to the trader:
- Pros: Easy to use, works well with other indicators, offers concrete guidelines for trade execution, functional on all time frames and securities
- Cons: Has the propensity to produce false signals, efficacy suffers in whipsaw market conditions, sudden volatility or prolonged consolidation can render ineffective
The ascending wedge is a sought-after chart pattern for legions of forex, futures and equities traders. It is a bearish indicator and is frequently used to short the market and capitalise on topside reversals or downtrend extensions.
Typically, active traders and investors combine the ascending wedge with other forms of analysis to confirm validity. If traded within the context of a comprehensive trading plan, the ascending wedge furnishes the trader with a finite means of entering and exiting short trades effectively.