There is (or that should be) no trader in this world that is not knowing what a wedge is looking like and what the outcome of a wedge is going to be. A falling wedge is rising and a rising wedge is falling, says the book. However, is this valid all the time? Well, the answer is no.
There is a special type of triangular consolidation that just makes the wedge not looking like a reversal pattern anymore, but actually making a rising wedge exploding higher and a falling wedge to just slip to even more lower levels. That kind of triangle is being called a running variation of a contracting triangle and the fact hat the word running appears means that the pattern will end above/below the previous wave’s end.
These triangles are extremely vicious because the normal reaction of market participants would be, for example, to sell the moment when the 2-4 trend line in a rising wedge is broken, or to buy put options. However, if you do that, but the you see price coming back and taking the higher values of the wedge, make sure you understand that the wedge is actually going to explode higher and one should reverse the trade and buy call options.
How to Identify Wedges?
Wedges are patterns that form mostly at the end of an impulsive move or at the end of a trend but they also can form at the very start of it.
It is being said that if a wedge is forming at the end of a new move than that wedge is not going to retrace more than 50% of the whole distance from the beginning of the wedge until the end of it. In this case, what a trader needs to do is to take a Fibonacci retracement tool and measure the whole wedge, and starting with the 38.2% retracement level to start buying call options if the previous wedge was bullish and put options if the previous wedge was bearish as it means the wedge was a first wave in an impulsive move that should continue in the same direction.
In this instance, the thing that gives a clue regarding the first wave is to look to see if the 2nd and the 4th wave in the wedge are overlapping. If that is true, then your count is wrong as overlapping is not allowed in a first wave wedge looking like move. The tricky part with this wedges is that they are actually triangles and the only difference represents the place where they are forming.
If your count is corrective, namely it is labeled with numbers and not with letters, then chances are, your so-called wedge is a triangle.
In order to have the shape of a wedge, the triangle is called a running one, as last wave, wave e, is really small. This makes the triangle to have the wedge looking like shape and gives the opportunity to be a contrarian. The thing is that traders are looking for a rising wedge to always break lower which is not really the case as if it is a triangle, after the b-d trend line is broken market is not going to look back.
Traders are looking in a regular wedge, like we discussed here on Binary Options Academy too, for the 2-4 trend line to be broken before buying put options after a rising wedge and call options after a falling wedge. That is correct.
But one should keep in mind that wedges are not that simple to trade and if, only if, after the 2-4 trend line is broken, market is retracing back into the wedge and makes a new high (in the case of a rising wedge) or low (in the case of a falling wedge), then call options in the first instance and put options in the second one should be traded.
Setting the Expiration Date
The expiration date is not that difficult to be set because of the fact that the first move is a fake one. This means that the move that comes after the new high or low that we discussed above is the real one and it will always be more powerful. After all, any good move starts with a fake one, right? And just like that, using logic and experience, bad trades can be avoided as only by accepting the fact that rising wedges are not always falling as well as falling wedges are not always rising a trader has a competitive advantage in front of market.
And because market is formed by actions of other fellow traders (remember that market is moving as the classical supply and demand law is functioning – meaning someone needs to buy or sell in order for a market to move), it means that the majority of other traders will be wrong while this approach will bear some winning fruits.