How to Trade the Falling Wedge Pattern

Read our Advertiser Disclosure.
Contributor, Benzinga
August 2, 2023

As just about any experienced forex trader will tell you, technical analysis plays a pivotal role in identifying profitable trading opportunities. Occupying a well-established place among the classic chart patterns you can look for on exchange rate charts, the declining or falling wedge pattern offers a powerful tool for discerning potential bullish trend reversals and continuations. 

In this detailed guide to trading the falling wedge pattern, Benzinga explores the steps involved in identifying the falling wedge pattern and explains the art of trading it effectively so that you can start using it in your forex trading strategy of choice to enhance your profits. 

Disclosure: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 69% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

What is the Falling Wedge Pattern?

The falling or declining wedge pattern is a useful classic technical chart pattern. It often manifests itself as a bullish continuation pattern seen during uptrends where it consists of a consolidative and corrective decline followed by an upside breakout to continue the upward trend. 

The falling wedge can serve as a bullish reversal pattern when seen after a panicked climax trough. This desperate sell-out then yields a sudden upside reversal, often on heavy volume, to signify that a substantial bottom has been reached as traders running short positions take profits. 

When a falling wedge arises in an upward trend, it generally suggests the possibility of an impending bullish continuation in the market after a correction lower. Alternatively, when a falling wedge starts to take shape after a market decline, then it usually indicates a bullish reversal to the upside.

A schematic diagram of a falling wedge pattern in an uptrend. Source: Technical Analysis for Financial Markets Traders

As the schematic diagram above illustrates, the falling wedge pattern is characterized by its unique shape and structure, which is made up of two converging trend lines that both slope downward. The upper trend line of the falling wedge pattern is often referred to as the resistance line, and it connects the exchange rate highs that occur during the pattern’s formation. The lower trend line of the falling wedge is known as the support line, and it joins the exchange rate lows. 

As the falling wedge pattern evolves, forex market volatility should gradually diminish, leading to a narrowing trading range over time. This reduction in volatility signals that a potential breakout in the near future seems likely. 

The formation of this readily recognized pattern tends to increase the interest that observant technical traders have when the expected upside breakout eventually occurs. This can in turn enhance the move resulting from the pattern’s ultimate breakout to the upside.

Spotting the Falling Wedge Pattern on Forex Charts

To spot the falling wedge pattern on forex charts, traders use various tools, including trendlines, oscillators and candlestick patterns. It is important to observe multiple timeframes to gain a comprehensive understanding of the pattern's formation and its potential implications since the falling wedge pattern can occur across different timeframes, ranging from intraday charts to longer-term weekly or monthly charts.

Identifying the falling wedge pattern on forex charts requires a meticulous and systematic approach to ensure accurate pattern recognition. As one of the classic chart trading pattern types, you will need to develop a keen eye for detail and a comprehensive understanding of forex technical analysis tools. 

A step-by-step guide to help you spot this useful chart pattern and capitalize on its potential trading opportunities follows.

Step 1: Select the Right Timeframe and Currency Pairs

Begin by selecting the timeframe that aligns best with your trading strategy and goals. The falling wedge pattern can be observed on various timeframes, including intraday charts like the 15-minute or 1-hour charts that day traders might use and on longer-term daily or weekly charts that swing traders and trend traders use.

You will want to choose the currency pairs that are commonly associated with the falling wedge pattern. Major pairs like EUR/USD, GBP/USD and USD/JPY are frequently monitored by forex traders for this bullish pattern's emergence, although it can be beneficial to keep an eye on other currency pairs as well since the classic chart pattern’s appearance is widespread.

Step 2: Draw the Converging Trendlines

To begin identifying the falling wedge pattern, you will want to draw the converging upper and lower trendlines on the exchange rate chart that characterize this pattern if you see a promising chart formation developing. The upper trendline is also known as the pattern’s resistance line, and it should connect at least two or more consecutive lower swing highs. The lower trendline is the pattern’s support line, and it should link two or more consecutive higher swing lows. As you draw these trendlines, ensure that they form a downward-sloping wedge pattern with the exchange rate movement gradually converging between them.

Step 3: Check for Decreasing Market Volatility

One characteristic of the falling wedge pattern is the gradual reduction of market volatility as the pattern evolves over time. This is reflected in a narrowing trading range between the converging upper and lower trendlines of the pattern. The highs and lows of the exchange rate should demonstrate a clear pattern of getting closer together over time, which indicates the diminishing willingness of sellers to push the exchange rate lower aggressively.

Step 4: Confirm the Pattern's Validity

After drawing the converging trendlines and observing the decreasing market volatility, the next step involves confirming the falling wedge pattern's validity. Look for three or more touchpoints on both the upper and lower trendlines to ensure the pattern's strength. The more touchpoints, the more robust the pattern becomes.

Step 5: Analyze Volume During the Formation

Volume analysis is a key aspect of a falling wedge pattern’s confirmation method. During the formation of the falling wedge pattern, currency traders should observe how trading volume trends. Ideally, the trading volume should decrease as the pattern takes shape over time. This reduction in forex trading volume in the currency pair demonstrating the pattern reflects a decrease in selling pressure and signals the potential for a bullish reversal or continuation that generally arises after a falling wedge pattern completes.

Step 6: Use Oscillators for Confirmation

To further solidify the falling wedge pattern's reliability, forex traders can use an oscillator like the Relative Strength Index (RSI) or the Moving Average Convergence Divergence (MACD) indicator. Look for bullish divergence to arise between the exchange rate and the oscillator, where the exchange rate forms lower lows while the oscillator creates higher lows. This bullish divergence indicates a weakening bearish momentum and supports the potential for a breakout that will yield an upside reversal or continuation.

Step 7: Watch for Candlestick Patterns

Candlestick patterns can offer valuable insights into the falling wedge pattern's potential breakout timing. Keep an eye out for bullish reversal candlestick patterns occurring near the support line, such as bullish engulfing, hammer or morning star candlestick formations. These candlestick patterns can further confirm the falling wedge pattern is getting close to its breakout point, which can signal a potential sharp bullish move. 

Step 8: Monitor the Breakout

When the exchange rate breaks out above the upper resistance line of the falling wedge pattern, it signals that a bullish bias now exists and presents a potential trading opportunity to enter into a long position if other indicators confirm the breakout. After a breakout, traders need to closely monitor the subsequent rising move to validate its strength. The breakout should ideally occur with a significant increase in trading volume and a weakening in downside momentum to increase the probability of a successful long trade.

Remember that spotting the falling wedge pattern on forex charts requires a systematic and disciplined approach. By following the preceding step-by-step guidelines and combining technical analysis tools such as trendlines, volume analysis, oscillators and candlestick patterns, you can significantly improve your ability to identify this powerful chart pattern accurately. Mastering the art of recognizing the falling wedge pattern can pave the way for profitable forex trading opportunities.

Understanding the Psychology Behind the Falling Wedge Pattern

At the heart of the falling wedge pattern lies the intricate interplay of forex market participants' emotions and the underlying supply and demand dynamics that determine market exchange rate levels. 

Falling Wedge Seen During a Downtrend

If the falling wedge occurs during a downtrend, the bears have been in control for some time and have been keen to push exchange rates lower, but their conviction weakens over time. After a panic sell-out by weak longs, a falling wedge pattern may develop. 

Once this happens, bottom-picking bulls gradually become more assertive, and those who have been short start to take profits as they see downside momentum weakening. This creates a series of lower lows and lower highs that reflects a gradual shift in currency market sentiment amid a general reluctance to take the market much lower. 

This tug-of-war between bears and bulls results in the converging trend lines that illustrate a battle for dominance taking place in the forex market. Eventually, when the pattern breaks out above the falling wedge pattern’s resistance line, the bulls have triumphed, and a potential bullish reversal unfolds.

Falling Wedge Seen During an Uptrend

If the falling wedge develops during an upward trend, it tends to signal a corrective downward phase in the forex market that is evolving in a set of converging and overlapping waves. 

As some bulls start to take profits, others start to accumulate the currency pair on dips, expecting the market to eventually move higher. Once an upside breakout of the falling wedge occurs, more bulls flood into the forex market to take the pair sharply upward. 

Tips for Effectively Trading the Falling Wedge Pattern

Transitioning from pattern identification to executing profitable trades demands precision and strategic planning. To solidify your trading strategy and improve accuracy, seeking confirmation signals is crucial. That and other useful tips for trading the falling wedge pattern effectively appear below. 

Confirmation Signals for Trading the Falling Wedge Pattern

Incorporating candlestick patterns into your strategy such as bullish engulfing or morning star formations can improve your results when using this pattern. Using confirmation indicator signals is helpful in validating the falling wedge pattern's reliability. 

Indicators like the MACD indicator and the RSI can offer valuable insights into the falling wedge pattern's strength. This information helps you determine whether a good potential trading opportunity exists. For example, when the falling wedge pattern is identified, traders can look for bullish divergences on the RSI momentum oscillator that signals a potential upside reversal. 

Keeping a close eye on the trading volume during the pattern's formation can be very useful. A surge in volume upon the pattern's breakout can lend credibility to the market movement, further validating the pattern’s strong bullish bias.

Entry, Stop-Loss and Take-Profit Strategies

Timing is of the essence when trading the falling wedge pattern, and determining the optimal entry point when the forex market breaks out the pattern is imperative. Traders will often set their entry orders just above the falling wedge’s upper resistance line so that they get into the market once a breakout occurs that confirms the pattern's bullish bias. 

To mitigate risk when trading this pattern, it usually makes sense to place a well-calibrated stop-loss order safely below the pattern’s support line, which can safeguard your position against unexpected adverse market movements. 

When it comes to setting a target for taking profits, you can use the measured move technique. This involves projecting the pattern's height upwards from its breakout point to obtain a reasonable target. This action can aid you in setting realistic and rewarding profit objectives for your forex trades based on this pattern.

Another profit-taking technique would be to use historical exchange rate charts to identify significant resistance levels that are situated above the breakout level. Profits can be taken just ahead of these resistance points. You can shift your stop-loss order higher as the market moves in your favor to protect your winning position from turning into a loser.

Risk Management and Position Sizing

While trading any pattern carries inherent risks, the use of prudent risk and money management methods is the cornerstone of just about any successful forex trading strategy. To start with, you will generally want to implement sound risk management techniques, such as determining your stop-loss and take-profit order levels in advance based on your risk tolerance and expectations for the trade.

Using conservative position sizing methods, such as setting a predetermined percentage of your trading capital as the maximum you wish to risk per trade, helps ensure that a series of losses does not deplete your trading account. 

Finally, while using leverage can boost your profits, you will want to refrain from overleveraging to help safeguard your trading account against significant losses and keep you in the forex trading game for the long haul since the currency market does not always do what your analysis indicates.

Falling Wedge Trading Example

Consider a practical trading example to illustrate the application of the falling wedge pattern in practice. To start with, a technical forex trader identifies what might be a falling wedge pattern on the EUR/USD daily chart during a prolonged downtrend. They then watch for and await the occurrence of confirmation signals, since trading on a false breakout can be an easy and costly mistake to make. 

As the market dips, the RSI for the currency pair exhibits bullish divergence, signaling a potential upside reversal. The market for EUR/USD then starts to rally from its lower support line as sentiment becomes more bullish. 

Eventually, the market breaks out above the pattern's upper resistance line. This rally is accompanied by a notable surge in trading volume, adding conviction to their analysis. 

The trader enters into a long position just above the falling wedge’s upper resistance line and places a sensible stop-loss order below the pattern’s lower support line. Their take profit target is set using the measured move technique by projecting the pattern’s width upwards from the breakout point. 

Once profits have accrued on their position, they plan on using a trailing stop-loss strategy to protect their profits just above the breakeven point in case of an unexpected retracement. 

As the breakout unfolds, the trader sensibly adapts their strategy based on an analysis done in advance of different market scenarios that might occur. Going through this thought process ahead of time helps the trader ensure greater flexibility in their trading approach and a faster response to shifting market conditions.

Common Mistakes to Avoid When Trading the Falling Wedge Pattern

Even the most seasoned forex traders make mistakes. When trading the falling wedge pattern, traders must remain vigilant and disciplined to recognize and avoid falling into common pitfalls that can negatively impact their trading performance. 

Knowing about these potential mistakes and taking proactive measures to address them can significantly enhance your forex trading outcomes. Some of the most common mistakes to avoid when trading the falling wedge pattern include:

Mistake 1: Premature Entry

One of the most prevalent mistakes traders make when dealing with the falling wedge pattern is entering the trade prematurely, before receiving sufficient confirmation signals. It is essential to exercise patience and wait for the pattern to fully develop and validate its breakout. Entering too early can lead to false breakouts, resulting in losses and missed opportunities. Wait for the price to convincingly break above the resistance line with increased volume and confirming indicators before taking a position.

Mistake 2: Ignoring Confirmation Signals

Confirmation signals are critical in validating the falling wedge pattern's reliability. Failing to pay attention to these signals can lead to ill-timed trades. Oscillators like RSI and MACD, along with candlestick patterns, offer valuable insights into the pattern's strength and potential reversal. Ignoring these signals can lead to missed opportunities or, worse, entering trades against the underlying trend.

Mistake 3: Neglecting Risk Management

Proper risk management is the bedrock of successful forex trading. Neglecting risk management techniques when trading the falling wedge pattern can expose traders to significant losses and even total account depletion that can put you out of business as a trader. It is thus important to set appropriate stop-loss levels to limit your potential downside and protect your trading capital. You will want to avoid allocating an overly large portion of your trading capital to a single trade since this can increase your overall risk exposure and cause unpalatable losses.

Mistake 4: Overlooking Market Context

Focusing solely on the falling wedge pattern without considering the broader market context is a common mistake. It's essential to analyze the overall trend and market sentiment to determine whether the pattern aligns with the prevailing market conditions. Trading against the prevailing trend or ignoring significant support/resistance levels can lead to suboptimal outcomes.

Mistake 5: Chasing the Breakout

While it is crucial to wait for confirmation of the pattern's breakout, chasing the breakout once it occurs is another mistake to avoid. Sometimes, traders might feel the fear of missing out (FOMO) and rush to enter the trade after the breakout has already happened. This impulsive behavior can lead to poor trade entry points and increase the risk of losses.

Mistake 6: Lack of Flexibility

Trading the falling wedge pattern requires adaptability to different market conditions. Staying overly rigid in your trading approach without accounting for changing market conditions can hinder your success. Those who stick to a single strategy without adjusting it to evolving market dynamics may miss out on profitable opportunities they could have benefitted from if only they had done something different. Since no chart pattern or strategy works perfectly all the time, remain prepared to modify your falling wedge trading approach based on changing market movements and sentiment.

Mistake 7: Overtrading

Overtrading involves executing an excessive number of trades. It remains a common mistake made by some forex traders. The allure of continuous trading can be tempting and even addicting to some people, but it can lead to overly emotional decision-making, reduced focus and less trading capital available for better trades. It makes more sense to focus on taking high-quality forex trades that align with signals provided by the falling wedge pattern and your overall trading plan, rather than making a larger quantity of trades than you need to.

Mistake 8: Ignoring Fundamental Analysis

While technical analysis is crucial in identifying the falling wedge pattern and trading based on it, neglecting fundamental analysis entirely is often a serious mistake. News events and economic data releases can significantly impact the exchange rate of currency pairs, so overlooking these factors can lead to unexpected exchange rate movements that affect your trades. Before entering a trade based on the falling wedge pattern, remember to check for important economic announcements and consider their potential influence on your trading decisions.

Avoiding these common mistakes when trading the falling wedge pattern should help you attain more consistent and profitable forex trading results. By exercising patience, using proper risk and money management techniques, staying adaptable and combining technical and fundamental analysis, you can typically improve your trading performance. 

Remember that learning from mistakes and engaging in continuous improvement are part of what it takes to become a more successful forex trader. You can do this by keeping a trade journal where you log and review your trading decisions to help you troubleshoot your trading strategy and how you execute it.

Can Forex Traders Benefit from Using the Falling Wedge Pattern?

The falling wedge pattern is definitely a powerful and potentially beneficial tool for forex traders seeking to capitalize on significant bullish market moves. This pattern is unusually helpful because it can be seen either in an uptrend or at the end of a downtrend. 

Although no trading strategy is foolproof, understanding the psychology behind the falling wedge pattern and learning to avoid common mistakes can substantially improve your ability to profit from identifying forex trading opportunities based on it.

By mastering the art of identifying the falling wedge pattern, using appropriate confirmation signals and implementing effective risk and money management techniques, you can improve your trading results considerably.

Frequently Asked Questions

Q

How often is the falling wedge pattern accurate?

A

The accuracy of the falling or declining wedge pattern varies based on market conditions, the timeframe under analysis and the presence of supportive confirmation signals. When correctly identified and confirmed, the falling wedge can offer a high-probability trading opportunity. Since no pattern is foolproof, however, traders should use multiple technical tools to enhance its reliability.

Q

Is a falling wedge bullish?

A

Yes, the falling or declining wedge pattern is generally considered bullish. It can occur at the end of a downtrend to serve as a bullish reversal pattern, and it also appears as a declining correction in an uptrend where it serves as a continuation pattern. The narrowing exchange rate range within the wedge reflects weakening bearish momentum and increasing demand that eventually leads to a bullish breakout once its upper resistance line is overcome.

Q

What does a falling wedge indicate?

A

The falling or declining wedge pattern indicates a potential bullish reversal after a downtrend or a bullish continuation when it occurs during an uptrend. It generally reflects a shift in market sentiment and rising demand that can potentially lead to higher exchange rates.

Get a Forex Pro on Your Side

FOREX.com, registered with the Commodity Futures Trading Commission (CFTC), lets you trade a wide range of forex markets with low pricing and fast, quality execution on every trade. 

You can also tap into:

  • EUR/USD as low as 0.2 with fixed $5 commissions per 100,000
  • Powerful, purpose-built currency trading platforms
  • Monthly cash rebates of up to $9 per million dollars traded with FOREX.com’s Active Trader Program

Learn more about FOREX.com’s low pricing and how you can get started trading with FOREX.com.

Jay and Julie Hawk

About Jay and Julie Hawk

About Julie: 

Julie Hawk earned her honors undergraduate degree from the University of Michigan before pursuing post-graduate scientific research at Cambridge University. She then started work in the private sector as a business systems analyst for a major investment bank, where she qualified as a Series 7 Registered Representative and received comprehensive training in various financial products. Further honing her skills, she attended the prestigious O’Connell and Piper options training course in Chicago, mastering professional option risk management techniques.

Julie then transitioned into the role of a professional Interbank forex trader, currency derivative risk manager and technical analyst, ascending to the position of vice president over a 12-year career in the financial markets. Julie’s illustrious banking career spanned working for major international banks in New York City, London, and San Francisco, where she served as an Interbank dealer, technical analyst, derivative specialist and risk manager. Her responsibilities included educating, devising customized foreign exchange hedging and risk-taking strategies, and overseeing large-scale transactions for esteemed banking clients, including corporations, fund managers and high-net-worth individuals. As part of her responsibilities, Julie managed substantial portfolios of forex options, spot, and futures positions as a currency options risk manager, earning recognition for executing innovative and highly profitable forex derivative transactions. Julie also spearheaded educational conferences on currency derivatives.

During her banking career, Julie attained world-class expertise in technical analysis, including Elliott Wave Theory, and pioneered research into automated trading and trading signal systems. An active member of the San Francisco Writers’ Guild, Julie also authored trade strategies, educational material, market commentary, newsletters, reports, articles, and press releases. She became a sought-after market expert who was frequently interviewed by financial magazines and news wires such as REUTERS.

Following her retirement from the banking sector, she dedicated 15 years to online forex trading, mentoring and freelance writing for TheFXperts, which she co-founded with her husband Jay. Julie is the co-author of “Forex Trading: A Beginner’s Guide” and “Technical Analysis for Financial Markets Traders,” in addition to five other books on financial markets trading and personal finance. She now focuses on writing articles on financial markets for platforms like Benzinga, although she continues to trade forex online and mentor fellow traders as part of TheFXperts’ financial team.


About Jay:

Jay Hawk grew up in Chicago and Mexico City where he became bilingual in English and Spanish. After taking formal training as a classical guitarist at prestigious music conservatories in Europe, Jay then embarked on a remarkable journey into the financial markets, cultivating his notable expertise through hands-on experience that began on the Midwest Stock Exchange.

His financial career progressed as he started actively participating in various exchange floor trading activities in the Chicago futures and options pits, where he worked his way up the ladder, serving as a clerk, trader, broker, investor and fund manager. Jay then ran a retail stock brokerage desk and managed funds for large institutional investors, leveraging his discretionary trading skills to yield profitable results for clients.

This ultimately led to Jay holding exchange seats and operating as a market maker on options exchanges in Chicago and San Francisco, initially on the Chicago Board Options Exchange. Jay also played a significant role in the Chicago Mercantile Exchange’s evolution, where he contributed to launching and actively trading the first listed currency futures options. After transitioning to the West Coast, Jay then held a seat and ventured into trading stock options and their underlying stocks on the Pacific Options Exchange.

Jay’s comprehensive understanding of fundamental economic and corporate analysis continues to inform his trading and investment activities and has led to his subsequent success as an expert financial writer. Together with his wife Julie, he co-authored “Stock Trading: A Beginner’s Guide”, “Commodity Trading: A Beginner’s Guide” and “Fundamental Analysis for Financial Markets Traders,” among their published books focusing on financial markets trading, market analysis, and personal finance. 

As an integral member of TheFXperts’ team, Jay now excels in trading forex online for his personal account, mentoring aspiring traders and writing for financial platforms like Benzinga where he specializes in covering topics related to the stock and commodity markets, as well as investing, trading and reviewing online brokers.