Falling Wedge Patterns: How to Profit from Slowing Bearish Momentum

Intermediate

Oct 26, 2021

13 min read

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The falling wedge is a bullish price pattern that represents a story about the market in which bulls are preparing for another push. In cryptocurrency trading, buying an asset from a logical position is more likely to provide success than randomly buying an asset without applying technical analysis. Therefore, keeping falling wedge patterns as a main pattern in your trading checklist is a great way to make money from the crypto market. This article explains the falling wedge pattern’s bullish indication in crypto charts, along with its use as both trend continuation and reversal pattern.

Is a Falling Wedge Pattern Bullish or Bearish?

A falling wedge pattern is bullish, although it appears after a bearish trend. It signifies that bulls have lost their momentum, and bears have temporarily taken control over the price. As a result, the price starts to make new lower lows, but at a corrective pace.

Crypto prices rarely move in a straight line. Rather, like most assets they tend to zigzag, with swing lows and highs forming, even if the price remains within a trend. Therefore, investors often experience temporary bearish correction within bullish trends, giving rise to patterns like the wedge, triangle, flag or channel.

These are signs that buying pressures are being reduced due to profit-taking. The uniqueness of the falling wedge pattern is that it can produce a higher accuracy of trade than a traditional descending channel.

Although both the descending channel and falling wedge are bullish reversal patterns, the falling wedge has better accuracy than the descending channel, whose price corrects lower by maintaining an equal distance between swing highs and lows.

On the other hand, with the falling wedge, swing levels squeeze toward each other, which is a sign of a deeper correction. Before making a trading decision, investors should focus on where the major trend is heading and how volumes are performing.

Pros and Cons of Falling Wedge Patterns

Let’s look at the pros and cons of the falling wedge pattern:

Pros

The falling wedge pattern frequently occurs in financial markets.
The falling wedge pattern works as both a trend reversal and trend continuation pattern.
Finding stop-loss and take-profit levels is easy.
This pattern offers a good risk-to-reward ratio.

Cons

The falling wedge needs additional confirmation when opening a trade.
This pattern has a weaker accuracy rate in lower time frames.
Novice traders often become confused when distinguishing between the falling wedge and other price patterns.

How to Identify Falling Wedge Patterns

A price pattern on a cryptocurrency chart isn’t randomly formed. Instead, it represents a story about buyers’ and sellers’ activity. Likewise, the falling wedge pattern, which occurs after a bearish trend, represents a narrative about what bulls and bears are doing — and what they might do next.

A bullish trend forms after a significant event by encouraging buyers to long an asset with the hope of future price appreciation. However, it’s often difficult for investors to hold this position for a long time. They usually book a profit after getting some benefit, often adding more positions when the price is discounted. As a result, the bearish wedge pattern that we see after a bullish trend is partially the result of buyers’ profit-taking. Once the profit-taking is over and the price finds a dip, investors will begin to buy again.

The trading approach with the falling wedge pattern is to find when the correction is over and the bullish trend is likely to resume. The global financial market is driven by institutional traders who need liquidity. There have to be enough buyers to sell and enough sellers to buy. Therefore, patterns like the falling wedge indicate that institutional traders who’ve created the bullish trend might open another buying position, resuming the trend after a discount.

The above image demonstrates a falling wedge pattern appearing after a bearish trend. Bitcoin’s price moves sharply lower from $64,000 to $30,000, but despite strong selling pressure, it doesn’t break below $30,000. As a result, the price remains corrective and forms a falling wedge. In this pattern, a new lower low and lower high are formed as the price remains within converging trend line support and resistance.

Besides swing levels, investors should monitor how the volume is changing. As the price moves to a consolidation phase, the volume should reduce due to less trading activity. However, once the breakout happens, it should be supported by higher volume.

The above image shows the same BTC/USD chart with the trading volume added. Here we can see that the volume is higher at the beginning of the falling wedge pattern, but volume bars start to move lower as the wedge pattern extends. Once the price moves up from the wedge pattern with a bullish breakout, the volume begins to rise again.

How to Trade Falling Wedge Patterns

A falling wedge is a reversal pattern, but investors can use it as both reversal and as continuation of a trend.

Falling Wedge Continuation Patterns

The price of a cryptocurrency moves by creating swing lows and highs. As a result, investors experience minor bearish swings within a major bullish trend. Therefore, a reversal from a minor swing level is ultimately a continuation of the major trend.

Let’s have a look at the image below:

In the above image, the major bullish trend is marked in green where the price is moving up by creating higher highs. However, when we look inside the bearish correction, we see the falling wedge pattern begin to form, with the major trend resuming after a breakout. Therefore, although the falling wedge pattern appears after a bearish trend, it’s still within the long-term bullish trend.

The above image gives a practical example of a wedge pattern as the continuation of a bullish trend on a real chart. Here, the BTC/USDT market trend is bullish, when a falling wedge breakout from the minor bearish swing resumes the trend and makes new, higher highs. Therefore, the trend continuation is confirmed once the price moves above the falling wedge with a bullish candle.

The image above shows how to open a buy trade from the falling wedge breakout. In this method, the buying setup is valid as long as the price remains above the wedge pattern’s low. In addition, the stop-loss should be below the swing low, with some buffer.

As the falling wedge pattern is a strong bullish continuation pattern, it often produces more profits. Therefore, traders can hold the buy position until the price reaches any significant resistance level.

Falling Wedge Reversal Patterns

With cryptocurrency trading, a falling wedge reversal pattern from a significant price level may provide more profits than it would in traditional markets. However, finding the right pattern from the ideal location is important.

The falling wedge pattern appears in a swing low, indicating that bears are losing their momentum. Therefore, the first sign of a highly profitable wedge pattern is to find it after a considerable downward movement. It’s hard to determine whether the bearish trend will continue or reverse, so finding the pattern at a bottom increases the probability of a trend reversal.

Look at the chart to see a strong downtrend at the beginning which is losing momentum at the bottom.

The above image explains how we can measure the strength of a bearish trend by looking at swing lows. If bears become unable to make new lower lows with a long distance, it’s a sign that they’re losing momentum.

Therefore, to trade the falling wedge pattern as a major market reversal strategy, we need to ensure the following confirmations:

The falling wedge pattern appears at the bottom of a downtrend.
The downtrend has become weaker before forming the wedge pattern.
There are at least three touches at trend line levels of the falling wedge.
Price reaches an important demand zone, from which bulls usually open their orders.

Let’s see how the falling wedge pattern works on a real chart:

In the above daily LTC/USDT chart, the price collapses from the $400.00 resistance level but loses its momentum at $105.00. Meanwhile, the price forms a wedge pattern, as supported by the decrease in volume. As a result, once the bullish breakout occurs, it shifts the trend from bearish to bullish.

The trading approach of the falling wedge reversal pattern is similar to the continuation system. The trading entry becomes valid when the price moves above the falling wedge pattern with a strong bullish breakout. Again, the stop-loss should be below the support level, with some buffer. Trading in higher time frames often allows traders to hold the gain for years. However, taking some profits from strong resistance levels is important.

The above image shows how to open the buy trade from the support level using the falling wedge pattern. The image clearly shows that the volume decreases with the wedge formation, which is a sign of lower trading activity. However, once the price breaks above the SL level, the volume starts to rise.

On the other hand, there is no guarantee that the price will come back to the support level after breaking above the falling wedge. In that case, traders can open the first buy entry immediately after the breakout, and the second entry after completing the correction.

Falling Wedge Patterns and Other Bullish Reversal Patterns

The falling wedge pattern is one of the bullish reversal patterns which form after downward pressure. However, there are many patterns which work like the falling wedge. Therefore, traders should know the key differences between the falling wedge and other patterns in order to better understand its trading accuracy.

Falling Wedge vs. Descending Triangle

Falling wedges and descending triangles look similar, and can confuse traders attempting to choose the correct pattern. The biggest similarity between the falling wedge and descending triangle is in their implications for price, allowing investors to understand what’s happening in the market and what might occur next.

These patterns usually appear after a bearish trend and indicate that bulls and bears are both losing their momentum. However, the price direction after the two patterns isn’t the same. Any bearish breakout after a descending triangle increases the possibility that the existing bearish trend may continue.

In the descending triangle, the price moves forward with lower highs forming, indicating that bulls are losing momentum. However, there are no lower lows formed, which signifies that sellers’ dominance remains unchanged. This repeated testing of the horizontal support indicates that the level is becoming weaker. Once the price moves below the descending triangle pattern, it will likely extend the existing bearish trend.

Now, let’s move to the trading approach using the descending triangle pattern:

Find a downtrend.
After forming a swing low, the price should move higher with a corrective momentum of less than 38% of the initial bearish trend.
Instead of extending the bearish movement, the price squeezes to a level between equal lows and lower highs.
Once the price breaks below the equal lows, the descending triangle breakout is confirmed, and investors can open a bearish position after the bullish correction.

Based on the above example, let’s distinguish the key differences between the falling wedge and descending triangle:

The falling wedge has both lower lows and lower highs, while the descending triangle has equal lows.
The falling wedge appears in a downtrend and indicates a bullish reversal. On the other hand, a descending triangle appears after a bearish trend and indicates a probable continuation.
The descending triangle doesn’t start from the beginning of a trend, so it has less profit potential than the falling wedge.

Falling Wedge vs. Bull Flag

The bullish flag pattern forms after a bullish trend, and moves lower by maintaining an equal distance between swing levels. It indicates that bulls are taking profits and they might continue the momentum. During the bull flag formation, the trading volume should dry up and push higher on the breakout. Identifying the bull flag in the price chart involves some complexity, as it contains several components. Traders need to have a clear understanding of bull flag components and trading approaches.

Let’s look at the approach to trading with a bull flag pattern:

Find an uptrend (flag pole).
After forming a swing high, the price should move downward in a sloping consolidation.
The overall retracement of the flag pattern shouldn’t be more than 50% of the major bullish trend, with the high pattern having a 38% to 50% retracement.
The flag pattern becomes ready to trade once the price breaks above the upper channel boundary with a bullish candle breakout.
After the breakout, wait for a considerable correction and rejection to confirm the entry.

The above image represents the key differences between the bull flag and the falling wedge pattern. Although both of these patterns work as bullish trend continuations, there are some key differences that a trader should know:

The bull flag forms after a long bullish trend, but the falling wedge appears at the bottom of a downtrend.
The bull flag maintains an equal distance between support and resistance levels, while the falling wedge squeezes the price between converging trend lines.
As the falling wedge appears in a downtrend and initiates an uptrend, it has a higher profit potential than the bull flag pattern.

The Bottom Line

While it’s difficult to find the ideal falling wedge pattern in perfect market conditions with cryptocurrency trading, investors can nevertheless apply the rules and concepts above to find lucrative trading opportunities.

Overall, falling wedge patterns are a great way to spot trend reversals and find profitable ways to buy before a new trend emerges. However, investors need to be aware of other factors that should be present to confirm the pattern. The key points that might help you to begin with this pattern are as follows:

The falling wedge is a bullish reversal pattern, appearing in the swing low of a downtrend.
There should be at least three touches at trend line levels in order to confirm the pattern as a wedge.
The pattern becomes tradable once the price breaks out above the trendline resistance with a strong bullish candle.
The trading entry is confirmed after a valid breakout and bearish correction. However, in some cases, the price may move higher without any retracement.
The ideal stop-loss approach is to set it below the near-term swing low with some buffer.