[Trends and Patterns] Reversal Chart Flow Attempting to Conceal the Persistence of Direction - Wedge Pattern

In the flow of stock prices and financial market indicators, there are often triangle-related patterns. In the previous article, we discussed the symmetrical triangle pattern.

Another typical pattern similar to a triangle is the ‘wedge’ pattern shown in the figures below. It's called a wedge in English, like a potato wedge… you know what I mean?;

The band formed by the two trend lines narrows from the entrance to the exit, similar to the symmetrical triangle pattern. However, the difference is that it is not horizontally converging, but rather forms while rising or falling.

There are rising wedge and falling wedge patterns. After this pattern is completed, it is known to signal a possibility of movement in the ‘opposite’ direction.

That is, a rising wedge pattern, after the pattern is completed and the exit narrows, signals a subsequent downward reversal, a bearish (bear) pattern. A falling wedge pattern, after completion, signals an upward reversal, a bullish (bull) pattern.

Among these, the rising wedge pattern often appears as a ‘bull trap’ case. High points continue to be renewed, with continuously positive stock market news, and then, the moment the pattern is completed, there is a high possibility of a sharp downward reversal.

Generally, a frequently observed form of this upward pattern, which consists of sub-waves, is a parallel channel. The upper trend line connecting short-term high points and the lower trend line connecting short-term low points rise almost parallel, and once the wave ends, the subsequent direction is determined by which way it breaks, upward or downward. Similar to the wedge pattern, this pattern also shows a higher probability of a reversal in direction. Still, regarding the direction after pattern completion, it is more fluid than the wedge pattern.

Now, considering that this usually proceeds as a parallel channel, let's consider a scenario where some of the main market players anticipate a future market or stock price deterioration and sell their holdings before reaching the expected parallel trend line at points (3) or (5).

In this case, depending on the strength of the selling pressure, the short-term high points at points (3) and (5) in the upper parallel channel may appear somewhat lower than the points expected in the parallel channel. Like the figure below.

This makes the parallel channel closer to a rising wedge shape. I believe that these supply and demand factors are the reasons why a wedge is formed. Therefore, in the case of a rising wedge, it seems to have become one of the typical patterns that predict a future downward reversal. Of course, the falling wedge is the opposite for the opposite reason.

The Elliott wave a-b-c waveform, whether upward or downward, represents a temporary correction. If the downward direction is the main impulsive wave, the technical rebound in the upward direction is also technically referred to as a correction.

When the market direction has changed to a downward direction, or when the upward/downward directionality has not yet been established, an upward a-b-c waveform often appears as shown below.

And in this a-b-c waveform, looking at it in detail, another frequently observed pattern is that the c-wave is further subdivided into visible sub-waves, stretching out long.

In this c-wave, it often appears as a wedge, as shown in the figure below. Occasionally, it also appears as sub-waves of a similar parallel channel pattern.

Considering the inherent possibility of future weakness in the rising wedge pattern itself, and its frequent appearance at the c-wave position in the a-b-c correction wave, the possibility of a future directional change is very high.

Even if the extension line connecting (1) to (5) in the figure below does not meet point (A), it is an acceptable pattern; however, cases where they do meet are also frequently observed.

Also, wedges are not always composed of 5 sub-waves; they can be composed of fewer, such as 3, or more, such as 7, so it is necessary to observe them with some flexibility.

As an example of the case where the c-wave in this a-b-c upward correction wave appears as multiple sub-waves, here is a long-term monthly chart of the Nikkei index in Japan, which I showed you once before. In the chart below, the latter part looks more like a parallel channel pattern than a wedge. Even if it is a parallel channel type, in such cases, the possibility of a downward reversal may be considered slightly higher, similar to a rising wedge.

Below are the long-term trends of the US Dollar Index (DXY) over the past several decades, shown as a monthly candlestick chart and a monthly closing price line chart. Since the US Dollar Index mainly represents the relative value of the dollar against the euro, which has the highest weight in the basket, the fluctuation range is smaller than that of the won/dollar exchange rate, so there is little difference between the candlestick chart and the line chart.

Just looking at the chart above may not evoke much feeling. However, by drawing simple trend lines, the feeling can change.

Below is a chart with simple upper and lower trend lines added to the monthly closing price line chart on the right, from the charts above. The feel of the chart seems to change somewhat. Looking at this large pattern, even in the mid-2010s, many would have probably anticipated that it would break through and rise toward the upper trend line.

Since even the US Dollar Index, which is mainly influenced by the value of the dollar against the euro, is moving in such a pattern, it's hard not to think that the won/dollar exchange rate, which showed a converging triangle pattern in the previous article, will move downwards.

Ultimately, it is likely that it is moving in that direction(?), and the fire is already lit and gradually burning. However, the key question is how long the burning wick will last—months, or 1-2 years?