Strategies


A GUIDE FOR TRADING RISING AND FALLING WEDGES

Technical analysis is the art of forecasting future prices based on previous patterns. As such, traders use various tools to get as much information when it comes to projecting prices. Some use indicators, like trend ones or oscillators. The idea is to find out discrepancies between the price and the indicator and, based on interpreting them, to find the perfect striking price for a call or put option.

Others, use trading theories. There are so many of them, that rookie traders will find it difficult to choose what is the best one. The answer is that there is no such thing as the best approach to trading financial markets because it is a sum of multiple actions. The technical analysis approach is just some part of the process that makes a trader succeed.

Like anything in life, trading is as difficult as one makes it. Besides technical analysis, fundamental analysis plays a vital role in interpreting a market. On top of it, and perhaps the most critical factor, market psychology and its impact on how traders react, will make the difference between losing and winning trades. Part of classic technical analysis patterns, wedges reverse a trend. Therefore, they appear at the end of a trend, and their shape tells much about the future market direction.

When a bullish trend ends, the price action evolves in a pattern called a rising wedge. The extremes become smaller and smaller, the price still rises, but with less power, the bulls yet step in on any dip, but with no conviction. Something must give, and, eventually, the bulls will capitulate.

The same pattern appears in a bearish trend, right before the end of it. Bears suddenly find out the price is supported on any new low made, while bulls prepare for a reversal. These two market behaviors appearing at the end of a trend, suggest the price will eventually reverse. Ralph Elliott was the first one to put some rules when trading a wedge.

According to the Elliott Waves Theory, the market moves in waves that reflect human nature, with fear and greed being priced in all the movements. At the end of an impulsive wave, the fifth wave tends to form a wedge. Because the waves are made of five wave’s structures of a lower degree, the fifth wave has five smaller waves. This makes the price action in a wedge moving between two trend lines that define the pattern.

All traders need to look before identifying a wedge, is to spot a series of two lower lows (ideally the third low follows too, but that isn’t mandatory) in a falling wedge. Next, they look at the opposite side of the price action and find the corresponding two lower highs. Connecting them results in the shape of a falling wedge, and all eyes stay on the so-called 2-4 trend line, or the upper trend line (the one that connects the two lower highs). That is the moment to trade a call option or the moment where the perfect striking price appears.

Obviously, the same is valid in the case of a rising wedge, with traders focusing this time on a series of two, ideally three higher highs that define wedge. The moment that the price breaks the lower trend line is the decisive one: it means the wedge broke and a put option is opportune.

 

 

But how to trade these patterns in such a way to keep a disciplined approach to trading and to incorporate the perfect striking price? The second part of this project explains the steps needed for that. In the first part, we defined what a rising and falling wedge are and the conditions for them to form. This section aims at providing classic examples and building a guide to trade binary options with these patterns.

Before anything, keep in mind that for a binary option indicating the future directions is not enough. In other words, when compared with other financial markets, only the price isn’t enough; time matters too.

As such, one of the most significant concerns in trading binary options is how to set the right expiration date. You may be right with your analysis and price moving in your favor, but if it reverses right before the expiration date, that’s not a profitable investment.

Wedges allow putting both the price and time elements behind a trade. Here is a step by step guide for trading a rising wedge, with similar steps needed in the case of a falling one:

  1. Make sure the market is in a clear bullish trend. If there’s no trend, ignore the wedge, even if the price pattern looks like one.
  2. Look for price to form a series of two, ideally three higher highs. By connecting the first two highs, you have the so-called 1-3 trend line from the Elliott Waves Theory. Typically, the third high comes and pierces this trend line. Aggressive traders buy a put option on that pierce, even though the risk for such a trade isn’t worth the reward. Why not? The answer is that the wedge is confirmed only after the opposite trend line, the 2-4 one, is broken. That’s the moment the wedge broke lower.
  3. Wait for the 2-4 trend line (or, the line that connects the previous two higher lows) to break. When this happens, buy a put option. Most of the times the price breaks lower and a spike follows that retests this line. However, this is not a rule of thumb, as many traders wait for the retest only to find out it’ll never happen.
  4. Measure the time taken for the wedge to form. In plain English, choose a shape and draw it from the moment the wedge started and until its end. That’s the time, and we use it to find the expiration date.
  5. Project that time on the right side of the chart, or after the wedge ended. Typically, the price retraces over fifty percent of the wedge in less than fifty percent of the time taken for it to form. That’s your expiration date for the put option.

 

Just like that, we’ve incorporated both the price and the time in a trade, and that’s all we need to trade binary options successfully. The opposite is true in the case of a falling wedge, with traders focusing on buying call options.

The two video analysis that come with these articles follow the same steps: the first one deals with explaining the concept, and the second one describes the steps presented here. Moreover, we use these steps in explaining a few trades, so that everyone understands the concept.

The beauty of trading wedges like this is that the patterns appear in every time frame. Because we project the time by effectively measuring the number of candles, both short-term and long-term traders can use the same approach.

 

 

 

Risk Warning: Trading may not be suitable for everyone, so please ensure that you fully understand the risks involved. Especially trading leveraged products such as Forex and CFDs carry a high degree of risk to your capital and can result in the loss of your entire capital. Only invest with money you can afford to lose.