How To Trade Wedges

*Bob Iaccino, Chief Market Strategist and Co-Founder of Path Trading Partners, joins us live every Thursday from 11am ET, as our risk management educator. With 30 years' experience working as an active investor in equities, commodities, futures and FX there are few better to talk on the subject of risk management.

Bob has developed a method for breaking down his key fundamentals of risk management, in a way that he thinks retail traders can understand and use to get actionable insights to bring into their own trading. Below are some excerpts of Bob’s thoughts from a recent live session.

I use wedges all the time. Wedges are basically channels – that's the easiest way to put it.

A wedge is a channel where the lower trendline is present, but within the upward-sloping or downward-sloping channel, there's also a second trendline. Somewhere inside the channel, market prices start to take the asset you’re looking at parabolic in one direction. What I mean by that is a more aggressive trend starts to emerge inside the trend you’re already observing.

Wedges are trading channels either sloping upwards or downwards, but with one small difference from traditional channels. The key difference that makes them a wedge is that either their upper trendline or lower trendline converges with the opposite line within the channel.

You want a trend channel in one direction or the other, and within that channel, you want a second trendline that goes in the same direction as the trend but at a steeper angle.

Essentially, when you talk about different kinds of wedges, you’ve either got rising wedges or falling wedges. It’s obvious that within that context, it’s either a bullish trend or a bearish trend. You must have the trend in the first place.

A wedge is a potentially short-term bearish signal within a longer-term bullish chart.

What we look for to trade these is a breakdown because the breakdown gives us a very clear target.

They’re one of my favorite patterns to trade because when you get a breakdown through the interior trendline that forms the wedge in the first place, you have a natural target: the bottom of the trend channel that the stock or asset was already in. That’s why wedges are useful.

Once you start seeing wedges, you can’t unsee them anymore. You’ll see them everywhere, and you’ll see how reliable a pattern wedges are. I think that’s one of the most critical thingsyou should take away when you start to line up wedges and start to see them. You’ll draw a lot of channels, both upward-sloping and downward-sloping, and you’ll see these moves that are parabolic within the channel. You could right away think this might be a wedge.

Wedges are very, very, very reliable. That doesn’t mean they’re 100%, because they’re not, but they’re very, very reliable.

They are, but they develop very quickly. You have to have your channels already drawn, and then when something moves parabolic, you draw that second trendline, whether it’s up or down, and then you watch it. You can’t take your eyes off it.

That’s part of the reason I don’t love short-term charts; I like to walk away from my screen. But once that wedge develops, you have to trade it quickly and you have to get out quickly because they move very fast and sometimes they move even before you’re able to get in them. But they’re extremely reliable patterns, so start looking for them.

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