A wedge occurs in trading technical analysis when trendlines drawn above and below a price series chart converge into an arrow shape. Wedge shaped trendlines are thought by technical analysts to be useful in analyzing a short to intermediate term reversal of what the analyst feels to be the major price trend.
Wedges can signal either bullish or bearish price reversals. (See also: Analyzing Chart Patterns: The Wedge)
Wedge technical analysis can be advantageous because it can provide some forward-looking insight on the price movement of a security. Generally, most traders will follow the upper and lower trendlines that form a security’s price channel. Often these trend lines will be upward or downward sloping indicating bullish or bearish trends. When prices start to converge toward a reversal point, then a wedge is formed. The wedge can help point to the range of prices where a reversal may occur providing a signal for future trading strategies.
When a security’s price has been rising over time, trendlines drawn above and below the price chart pattern can converge to show a potential reversal point at a peak. This reversal point can indicate a bearish price point signal in which the security’s price is subsequently expected to reverse lower. When a rising wedge points to a bearish reversal point, traders would likely begin taking bets on downward price movements in the security. Bearish trades at the reversal point could include selling the stock or short selling the stock through margin borrowing. These trades would seek to profit on the potential that prices will fall.
When a security price has been falling over time, trendlines drawn above and below the price chart pattern can converge to point to a bullish reversal signal. At this point the stock would be expected to reverse higher. Traders identifying bullish reversal signals would want to place bets that the security’s price will rise once a certain price point is reached. If a bullish signal has been identified on the horizon a trader could potentially buy call options on the stock at the low price indicated by the falling wedge trough. A trader could also initiate a below the market limit order as the pricing chart approaches a potential trough. Generally, in all scenarios resulting from the identification of a falling wedge price point, a trader would seek to gain on the potential for the security’s price to begin rising in the future.