The next pattern is the wedge. This is similar to the pennant, but it uses a different shape. A wedge is a pattern where the price wave reverses. The range in a stock’s price will start to narrow after a while. The stock will break out and move up or down after the wedge ends.
What makes the wedge different from a pennant? A wedge is organized based on the differences between stock prices within a certain range. Here’s an example of how a wedge may be formed:
- You might notice a trend where the price of a stock moves up and down and then back down again. For instance, a stock might start at $100 and then move up to $120 after a few days. The stock would then fall to $105 after another couple of days.
- The extremes between the first values will start the wedge. The wedge will feature two lines just like with a pennant. The first line starts at the $120 part and the other starts at the $100 mark.
- The lines on the wedge will move inward based on the changes in the stock range. You might notice in a few days that the stock will go from $105 to $115 and then to $112. The lines will become narrow as the gap between price extremes starts to shrink.
- After a while, the wedge will shrink to where the price might appear to break out. You can identify if the wedge is bullish or bearish by looking at how the wedge began. If the wedge began with the price moving up, there is a chance that the price will break out after the wedge ends.
The Three Types of Wedges
The main strategy to use when trading wedges is to look at how the wedges are organized. There are three shapes of wedges that you might notice with each being different based on how a stock’s value is going to change over time:
- Rising wedge - This is where the highs and lows of the wedge keep moving up. You can tell when the wedge is rising that the stock is about to trend downward. You will have to sell your stock when the low on a rising wedge breaks beyond the lower bar. This is a sign that the stock is about to take a dramatic decline in its value and potentially move down further. Sometimes this might lead into a falling wedge. This is the next wedge.
- Falling wedge - The falling wedge is the opposite of the rising wedge. The highs and lows will continue decreasing. You should buy the stock when it breaks out from the top part of the wedge.
- Symmetrical wedge - A symmetrical wedge has a design relatively similar to that of a pennant. However, the narrowing of the gap will not be as close as it would be with a pennant. You can see if the wedge is going to move up or down by noticing how the wedge began. This is just like a pennant as a wedge that starts by increasing in value and will surely continue to increase.
These three wedges are designed with different arrangements but are all vital for helping you to see where a stock might go. Reviewing the layout of the wedge is vital for trying to get an options trade ready, which is the next point to look into here.
Take Profits on Options
The take profit should be analyzed when you get an options trade made within a wedge. The take profit refers to the starting point of a wedge. It is the high at the start of the falling wedge or the low when the rising wedge begins. You can order an option that lasts for a certain period of time and focuses on the take profit. The best strategy at this point is to decide how long a wedge is going to develop. This could give you an idea of how long the option you wish to place could be. You should keep the option long enough to give the stock the opportunity to get back to the take profit point. This is regardless of how long it might take for the wedge to move.
