A wedge is a five wave structure that should always be labeled with numbers (1-2-3-4-5) and it has many interpretations in the trading world.
Some say a wedge is a reversal pattern (which it is true but only to a certain extent) but not all the time as you can see watching the four recordings we have made for explaining how to trade binary options using wedges and, more importantly, how to take the time element into consideration, which is even more important.
When trading, there is a saying that a rising wedge is falling and falling wedge is rising, meaning that by the time a rising wedge is identified, then the logical thing to look for is for price to reverse and break to the downside. The opposite is true as well, as whenever a falling wedge is identified, the thing to do is to look for price to reverse and break to the upside.
Like mentioned earlier, a wedge is a five wave structure and it is contained by two trend lines: the 1-3 and the 2-4 trend line. Therefore all eyes should be on the 2-4 trend line and the moment the trend line is broken as most of the times this implies the wedge is completed and the previous highs/lows are there to stay for a while.
Of course, like any other patterns, the higher the time frame, the more important the pattern so one is to treat a wedge on the lower time frames like the five minutes chart for example and a totally different story is to trade a wedge on a daily chart.
However, this matters little when trading binary options because in order for an option to expire in the money it is enough for price just to be one pip higher than the striking price in the case of a call option, or one pip lower than the striking price (the price you bought the option for).
The recording above deal with both falling and rising wedges and, more importantly, shows you what to look for when trading them.
First of all, a trader should know that a wedge can appear at the beginning of a trend, in the so called first wave, and this implies that by the time the 2-4 trend line is broken the correction should only be as a second wave type, not breaking the previous lows/highs.
Also, it should be mentioned that in the case a wedge appears as a fifth wave type according to the Elliott Waves theory each and every leg of it can be either corrective (if we’re talking about a terminal impulsive move) or a classical impulsive move (if we’re talking about a first wave extension). In both cases, the rules of an impulsive move should be respected and look for all the confirmation rules to be there.
Second, in the case of a falling wedge for example, the normal reaction is to look to buy call options as this pattern implies further upside to come. However, when to do that? Well, the answer lies with the 2-4 trend line. A clear break of the line is usually being followed by a retest of it and that is the moment we should engage into buying the call options. More details to be found out by watching the recordings above.
One thing to remember is that a retest of the 2-4 trend line, while it happens quite often, it is not mandatory, as sometimes price is just exploding higher out of a falling wedge and never look back. However, in order to be on the safe side with the entry place for buying the option, a retest of the 2-4 trend line is recommended.
The expiration date varies depending on the time frame the wedge is identified, so if we are talking about a wedge on the hourly chart and the 2-4 trend line is broken and retest it we can talk about end of day expiration date but even one hour expiration date as well.
But how to incorporate the time element into the analysis? Well, there is a strong tendency for the wedge to travel to the 50% retracement level in less than the time taken for the whole wedge to form.
So the logical thing to do is to take two vertical lines, measure the whole length of the wedge and then project the outcome on the right side of the chart. If price is not retracing to the 50% level in less than that time, it means the structure you are analyzing is not a wedge and therefore the analysis should be reevaluated.
Clear examples are to be found in the recordings above.
I will end this series about wedges with the example that we actually started the article. Are wedges reversal patterns? The answer is no and the reason for that is the fact that sometime price is just exploding higher out of a rising wedge and this pattern is called a running variation of a contracting triangle, it is a special type of a triangle, and it has nothing to do with wedges, even though the structure of the wave is exactly the same.
On our next project to be uploaded on the website and on the Youtube channel this week we will show you How To Treat A Contracting triangle.