Hello to everyone out there, I would love to join Prof. @sachin08 to welcome each and everyone to the first week of this season. The topic for this week is Trading Using Wedge Pattern and I'll try my best to give detailed answers to the test questions listed. If you reach the requirements, you could join me to do same by reading up the lesson on this link.
1.)
Explain Wedge Pattern in your own word
Introduction
There are different techniques out there in which professional traders use to predict the next trend in the market. Some of which are the fundamental analysis and also the price action analysis. The lesson taught by the Professor this week is based on the Price action technique so I'll try my best to explain deeper.
For those of us who don't understand what the price action is, the price action analysis is a trading strategy which uses the history of past price movements, formation of price patterns on the chart, hereby producing support and resistance levels in order to predict future prices or new trends in the market without the use of indicators.
Explanation of Wedge Patterns
Above is the picture of a wedge and that's exactly what the wedge patterns looks like, a bit triangular. From our literary understanding of wedges, a wedge is just a tool used for support to hold objects in position and this is the same principle we see in the wedge patterns, the price consolidates inside the wedge before a break out.
A wedge pattern is a pattern on the price chart where price movements are seen to be converging. This means that at the moment of the creation of these wedges, the market is experiencing a consolidation in prices (no trend in the market), where the price movements produce a wider shape at the beginning before they are bounded by two trendlines which converge the price pattern until a breakout is experienced. This creates a continuation in trend or a reversal in the trend.
These two trend lines at the top and bottom are known respectfully as the resistance level in the market and the support level. In event of a breakout at the resistance level, we will experience an uptrend in the market and a breakout at the support level creates a downtrend.
Let me explain further with an illustration of a spring, imagine we compress a spring with our index finger at the top and our thumb below. Which means the spring is confined in between our fingers and this is the same way the price movements are confined in the wedge pattern. Let's make our index finger the resistance level and our thumb the support level.
Eventually, if we try to release the spring, what ever finger we pull out first will be the direction the spring will shoot out to. Meaning if we pull out our index finger, the spring will shoot up and if we pull out our thumb, the spring will shoot down. Taking the spring as the price movements in the market, this is the same principle with the wedge pattern, at a point close to the convergence, the price action will break out at either of the trendlines and this will initiate an uptrend or downtrend.
Above, we can see a BTC/USTD chart from trading view which has a representation of a Wedge pattern. I have tried to label the chart for further understanding.
We can see that the price action moved in a zigzag manner producing a wedge pattern. Inside this wedge, the market was experiencing consolidation, the buyers and sellers of BTC were unsure of the next trend in the market. Price moved bullishly from point A to B, then bearishly from point B to C, this then continued to point E until the price action broke out of the resistance level and the buyers took over the market producing a bullish trend.
NOTE: The price action must touch the lines 5 or more times to be sure its a wedge. Ofcourse, the higher the touches the stronger the accuracy of your prediction. Also the trading volume at the point of wedges are always since to be reducing.
This is a brief explanation of how the wedge pattern works, the price movement will have to converge, contracting its shape until a continuation or reversal in trend is experienced in the market. This all depends on the direction the apex of the wedge pattern is pointing to. I'll explain further in Question 2.
2.)
Explain both types of Wedges and How to identify them in detail
Now you've read my explanation on wedges, I'm sure your have a proper understanding of the concept, so I'll just get straight to defining the two types of these wedges. There are two types of wedges
- the Rising wedge
- and the Falling wedge
Let's start with the rising wedge:
The Rising Wedge
The rising wedge, also called a bearish wedge pattern is a wedge pattern which has higher highs on the resistance level and higher lows on the support level. This means that the two trend lines in this type of wedge are seen to be converging towards the upward direction. From our normal analogy of trends, if the price movements in the market are moving towards the upward direction, it simply means that the market is experiencing an uptrend but in the case of rising wedges, this slight trend begins to converge and this convergence indicates that the current uptrend in the wedge is losing its strength hereby causing a breakout close to the apex of the wedge. This results in a downtrend.
There are two types of rising patterns and one represents a continuation of trend while the other represents a trend reversal. I will represent them in a diagram below
In the continuation rising pattern, the market was already experiencing a downtrend before it consolidated to form a wedge. After the formation of the wedge the price broke out and still continued in a downtrend. This continuation rising pattern simply analyses that there will be a continuation of a downtrend after the wedge shaped consolidation.
On the right hand side, we can see the reversal rising pattern and this means there will be a change in the trend in the market. The previous uptrend in the market will take a turn to become a downtrend, meaning traders should prepare to sell their assets.
This is the ETH/USDT chart from trading view. The price action moved in a zigzag manner, touching the trendlines a total of 5 times at point A to E. We can see that the wedge shape was formed with its apex pointing in the upward direction. Meaning this is a rising wedge and a downtrend is about to be formed after a break out. A trader can start creating a sell order so that once the price breaks at the support level, he would quickly input his take profit and stop loss to minimize risk. I will explain more on how to make this trade later on.
The Falling Wedge
The falling wedge or bullish wedge is a wedge pattern which has lower highs and lower lows consolidating on the resistance and support levels. Meaning, the two trend lines in this type of wedge are seen to be converging towards the downward direction. Indicating that the downtrend is losing strength and there will soon be an uptrend in the market. There is a little uncertainty between the buyers and sellers in the market which cause this consolidating zigzag price movements. At a point close to the apex of the falling wedge, the price breaks at the resistance level to produce an uptrend.
There are also two types of the falling wedge
In the image above, we can see two kinds of falling wedges, the continuation falling wedge pattern and the reversal falling wedge pattern. The continuation displays that the market was already in an uptrend before the formation of the wedge. After this wedge, the market will still continue in an uptrend like we have seen above.
The reversal falling wedge pattern displays or indicates a change from the previous downtrend to an uptrend. Which means traders should prepare to buy the assets.
This is a BTC/USDT chart in the picture above. We can see that the price action moved in a zigzag manner touching the trendlines 5 times. The chart converged towards the downward direction which indicates there will be a change of trend in the market to a bullish trend. After break out at the resistance level, the trader can decide to fix a buy order.
I'll give some steps on how to identify and mark out these wedges. The steps are quite the same for the falling wedge and the rising wedge. I'll try to specify properly below.
To identify this wedges, we will need to do some technical analysis on a chart. Like I said, the wedge is a price action technique and the price action technique doesn't need indicators. Let's head straight to the steps.
Selecting A time frame: Once you have decided the coin pairs you would love to trade on, this is the first thing you would have to do. You would need to pick out a time frame based on the kind of trader you are. If you make short term trades, you could use the 15 mins chart or the 1 hour chart. For long term traders, they could use the 4 hours chart or 1 day chart. Although, the wedge pattern are better for long term use.
Drawing out Your trendlines: This is the difficult part of the wedge pattern analysis. When the wedge pattern starts, it isn't really easy to identify it until a few hours or days later. So, this will need a trader to always be on the chart, monitoring it so he doesn't miss out on trades or make late entries. You can use trading view to draw these lines. I will separate this step into two other steps to explain better.
Drawing the resistance level: The wedge pattern requires two trend lines to be formed. For the first, once you observe a zigzag pattern on the chart, you will need to draw the trend line at the top of the price action, joining the first two higher points of the price action together.
Drawing the support level: Also, you will draw another line at the base of the price action, joining the first two lower points of the price action together.
NOTE: Draw this lines to intersect each other and form a wedge shape.
Interpretation of the trend lines: After drawing the two lines, you have to observe closely to identify the direction the apex of the wedge is facing. If the apex is facing the downward direction, it is a falling wedge and the trader will have to prepare to make a buy trade. But, if the apex is facing the upward direction, it is a rising wedge. Which means the market is about experiencing a downtrend.
Observation and Analysis: This is the point where the trader has to wait patiently and observe if the price action in the market is being guided by his drawn out trend lines. The trader has to watch closely to ensure that no candle stick closes out of his wedge pattern. If this happens, then the trend lines were wrongly drawn, he may need to redraw it again if possible.
If all candles fall inside the wedge shaped trendlines, and also flow in a zigzag manner which touches the trendlines for more than five times. We have successfully identified a wedge pattern.
Trading Volume: For a falling wedge and rising wedge, the trading volume below the trading view chart will have to be decreasing. This confirms that it is a good wedge.
3.)
Do the breakout of these Wedge Patterns produce False Signals sometimes? If yes, then Explain how to filter out these False signals
For every method of technical analysis, there is always a possibilty of false signals. So, I stand firmly to say, YES, sometimes wedge patterns can produce false signals to traders. Of course, this has to be true, if not all traders will be billionaires. This false signals could be because of some news from whales or just poor analysis. Let me give you an instance.
If we look at the image above we would see the a falling wedge pattern. I highlighted the trend lines in blue. From our knowledge of the falling wedges, we should expect a breakout on the resistance line which should lead to an uptrend. But in this case, the price tries to burst into to an uptrend, but we see that the price action hits another resistance point and goes into a bearish trend. This is a solid example of a false signal which could lead a lot of traders who didn't set stop losses to extreme losses.
The question now is "how do we solve or filter this false signals?". I know I must have said a lot of times above that the price action technique doesn't require indicators but we must know we are just humans and can not foresee the next price in the market. No matter the price action analysis we do, there is still risk of loss. My solution to filter this signals is by combining the wedge pattern analysis with the use of one or two indicators. We should avoid using so many indicators to avoid confusions ( like the popular saying states, "too many cooks spoil the broth").
From my research and analysis, the best indicator to combine with the wedge pattern is the 20 day Moving Average. Like I stated above, in question 2, the best type of trading to do with the wedge pattern is long term trading. So we will need a lagging indicator like the 20 day moving average to assist us for this purpose. While the price action displays the current price in the market, the moving average oscillator with the help of certain analytical calculations, tries to accurately define the next trend in the market. Let me give an example.
This is the moving average on an accurate wedge pattern. The indicator points the direction of the next trend perfectly. Also, it lies right below the bullish trend to act as support to it. We should note that when the moving average lays below the price action, it signifies an uptrend and when a moving average lays above, it signifies a downtrend. We can see that in the chart above. Now let's apply this on the faulty chart.
At the point of breakout, the indicator did point to the upward direction to signal a bullish trend, rather it crossed the bullish candlestick at the breakout point and kept on moving horizontally. This indicates that there won't be an uptrend yet. Suddenly, after that candle stick, the moving average crossed the candles and laid about them which indicates the beginning of a downtrend.
When we see such a horizontal pattern of the moving average at the point of break out, we should try to kept calm to see if the next candle will surpass the breakout candle.
We can see that with the 20 days MA indicator, we can filter false signals.
4.)
Show full trade setup using this pattern for both types of Wedges.( Entry Point, Take Profit, Stop Loss, Breakout)
To be able to become successful traders with the wedge pattern strategy, you will need to learn when to make and an entry and also when to let go of greed and take your profits. Every trader has a particular method of making their trade. I'll try to give a trading setup of how to make profit with the wedge pattern.
For the Falling Wedge Pattern
Above is the trading set up of the falling wedge pattern on the SOL/USDT chart. As you can see, I've drawn out my trend lines in Blue, the upper representing the resistance level and the lower representing the support. I used an arrow to identify the breakout point.
Selection of entry-point: Entry point should be at the point of breakout in the market. Although for safe traders, you can still enter a buy order from the next candle after the breakout candle. I highlighted the entry point at the base of the lemon transparent rectangle, which is $156.5 in the market.
Selection of Take profit: The take profit should be at the same length with the height of the wedge. That means, you have to use the height of the wedge to make your take profit level from your entry point. For further understanding, you can check the setup above to see my "dimension lines". The take profit price is $165.7 in the market.
Selection of Stop Loss: The stop loss should be the same length with the height between the base of the lowest candle of the wedge to breakout point. I highlighted it with a transparent red rectangle. The stop loss price is $154.5 in the market.
From our values, if a trader entered the market with $10,000, lets calculate his profit
For the units of SOL he initially bought,
=$10,000/$156.5
=63.898 units of SOL
To get the his returns in USD
=63.898*165.7
=$10,587.86
Therefore the profit will be $587.86
For the Rising Wedge pattern
I have drawn out my trend lines so that you can see the rising wedge above.
Selection of the breakout point: You need to mark the point where the bearish candle crosses the support level.
Selection of Entry Point: This should normally be at the break out level although safe traders can mark their entry points at the candle next to the breakout candle. I highlighted the entry point at the top of the transparent lemon rectangle. The entry price is at $0.2234
Selection of the take profit: This point should be measured below the entry point since we are making a sell order. The length of that point should be the same with the height of the wedge. The take profit price was $0.2138.
Selection of Stop loss: The stop loss should be at a height fro the entry point to the highest candle stick in the wedge. The stop loss price is $0.2255.
From our values, if a trader sold 45,000 DOGE, lets calculate his profit
For the price of the units of DOGE coin he sold,
=45,000*$0.2234
=$10,053
When he buys back the coins, he will have
=$10,053/$0.2138.
=47,020.58 DOGE
Therefore the profit will be 2,020.58 DOGE
From all my analysis and research I made while doing this assignment, I can strongly say that the wedge pattern is one of the most accurate price action techniques I’ve used. I must say, while doing question 3, it was so difficult for me to find a faulty wedge pattern.
A lot of traders today use this method of analysis to make big profits. I too myself plan to try it out on my next trade.
I so much thank Professor @sachin08 for this wonderful lesson.