Last monsoon I was trudging home on a somewhat flooded street, when I saw a child standing on the sidewalk with tears brimming in his eyes and a heartbroken expression that could have melted an iceberg. I was about to ask him if he was stranded or if he needed help contacting his parents when I saw - wedged between an umbrella, a school book and a pencil box - an icecream cone. Tilting downwards. The flood had washed away any evidence of a fallen dollop of icecream but it was clear (from the tilted cone, and the fact that the icecream itself seemed to have broken free of its cone) that the boy's icecream had fallen into the rainwater.
The rising wedge pattern reminds me of the tilted ice cream cone and the fallen icecream. A downward tilting cone (or wedge) appearing as a set of trend lines on a stock graph acts as grounds for traders to predict that the stock price is going to fall. Of course a second clue is required here too. Like the icecream that had slipped out of its cone, when the stock price breaks out - by slipping below its recent lows - traders regard it as supporting evidence in favour of predicting a stock price decline.
So how does this cone-slash-wedge shape become evident on a stock price graph? Very simply, a series of stock price highs and lows line up to form a set of converging trendlines. These trend lines ascend as they converge - broader to the left side of the graph and narrower to the right side of the stock price graph. To be clear, this means that the lines were further away from each other in the past and are closer together at present.
Traders predict that the stock price - which has been on the rise - will see a trend reversal when the stock price breaks away below the lower trend line. They see this as a sign that the market is fighting back against the price increase.
But, wait …. Not so fast!
There are a handful of accompanying signs that should be observed before jumping to the conclusion that a stock price increase is about to be reversed
1 - stock prices for the last 10 days up to 50 days must line up to form a tilted cone or wedge.
2 - the upper and lower trendlines must be moving towards a convergence that is they get narrower towards the right side of the graph.
3 - the slope of the convergence is tilted upwards because the stock high price is on upward trend
4 - Volume, a technical tool that traders use to evaluate of market interest, shows a decline.
5 - the stock price breaks out below the lower trendline, that is, the stock price deviates downward suddenly, a further drop from the trajectory observed recently.
Rising wedge patterns are also referred to as ascending wedges - they are considered to be a sign of an impending bearish trend.
For this very reason, the rising wedge pattern is not to be confused with its similarly named twin: the falling wedge pattern. In the case of the falling wedge pattern, the cone-slash-wedge is pointing upwards but also narrowing towards the right side of the stock price graph. The falling wedge pattern - in contrast to the star of today's podcast - is a bullish pattern. It heralds a stock price increase.
A few minutes ago I mentioned that traders expect a reversal in the stock price when they see a rising wedge and its accompanying breakout below the lower trendline. However a rising wedge pattern can also be a continuation pattern. Now before you let that statement boggle your mind with how contradictory it sounds let me add that... One - it all depends on where the rising wedge pattern appears, that is after a downtrend? or after an uptrend? And two - in reversal pattern avatar or continuation pattern avatar, traders regard the rising wedge pattern to be a bearish pattern.
So to sum up, if a rising wedge pattern with its accompanying breakout below the lower trendline appears after a downtrend, it is seen as a continuation pattern. Traders expect prices to continue to decline. Conversely, if a rising wedge pattern with its accompanying breakout below the lower trendline appears after an uptrend, it is seen as a reversal pattern. Traders expect prices to start falling. In both avatars, the rising wedge pattern predicts a price decline. In both avatars it is referring to the continuation or discontinuation of the trend before its appearance.
The rising wedge pattern, along with its twin - the falling wedge pattern, are considered to have a very good strike rate in panning out as accurate indicators. Traders say that predictions made off of wedge patterns more often than not, have proven correct.
That said, there are the usual rules of caution that I must call to mind when praising the prediction-worthiness of the rising wedge pattern. One - no indicator alone can be considered as basis enough to make an informed prediction. Moreover, rising wedges are fairly hard to spot without doubt, according to traders. Two - even if all the indicators and even the overall sentiment towards the stock point to a certain price decrease it is important to note that the actual stock price movement could still oppose the prediction.
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