Education

KUCOIN:LYXEUSDT   None
In our previous post in this series about chart patterns we described the characteristics, rules, and causes of triangle patterns (if you haven't seen it, see the related idea below).

In this post, we perform an advanced analysis of broadening wedges patterns. We provide a description of each pattern and its implications. We also review the literature in order to find their deterministic cause.

Broadening wedges are characterized by price variations laying within one support and resistance, both having the same direction and broadening over time. As such the apex of the support/resistance in a broadening wedge is located to the left.

Broadening wedges must not be confused with other broadening formations. While they all have a broadening characteristic they can have different identification rules

Broadening wedges are classified depending on the direction of the support/resistance.

1.1 Ascending

Ascending broadening wedges mostly occur during uptrends with rising local maxima (higher highs) forming an upward sloping resistance and raising local minimas (higher lows) forming an upward slopping support. The slope of both the support & the resistance should be significantly different from 0.

Bulkowski suggests the price needs to test the support and resistance three times each. Additionally, the resistance should be steeper than the support.

Volume tends to increase during the formation of such pattern.

Ascending broadening wedges have a bearish bias with breakouts mostly occurring downward. Downward breakouts are often followed by a decrease in price.

Example of an ascending broadening wedge followed by a downward breakout on SOLUSDT 4h.

1.2 Descending

Descending broadening wedges mostly occur during downtrends with declining local maxima (lower highs) forming a downward sloping resistance and declining local minimas (lower lows) forming a downward slopping support. The slope of both the support & the resistance should be significantly different from 0.

Similarly to ascending broadening wedges, Bulkowski suggests the price needs to test the support and resistance three times each. Additionally, the support should be steeper than the resistance.

Volume tends to increase during the formation of such pattern.

Descending broadening wedges have a bullish bias with breakouts mostly occurring upward. Upward breakouts are often followed by an increase in price.

Example of an ascending broadening wedge followed by a downward breakout on AVAX 1h.

2. Partial Rises/Declines

Partial rises/declines are phenomena described by Bulkowski in broadening formations and are described as being common. Partial rises/declines often indicate the direction of a breakout.

Partial rises commonly occur in broadening ascending wedges, price bounces off the support, moves towards the resistance without reaching it, and go back to the support. We can expect a potential downward breakout after that. Note that a partial rise always starts from the test of the support.

Partial declines commonly occur in broadening descending wedges. The price bounces off the resistance, moves towards the support without reaching it, and then goes back to the resistance where we can expect a potential breakout upwards. Note that a partial decline always starts from the test of the resistance.

Partial rises and declines can offer a better price to buy/sell instead of waiting for a breakout.

3. Measure Rule

The measure rule for broadening wedges allows us to determine the position of a take-profit/stop-loss.

For a broadening ascending wedge the measure rule would place our take profit at the lowest low inside the formation. Selling directly after a partial rise would allow for higher profits.

For a broadening descending wedge the measure rule would place our take profit at the highest high inside the formation. Selling directly after a partial decline would allow for higher profits.

Certain analysts close trades caused by partial rises/declines when the price reaches the support/resistance of the wedge, opening a new position in the case of a breakout while using the metric rule for setting their take profit.

Bulkowski offers a description of the causes of broadening wedges in the market in terms of the market participant's behavior.

The cause of an ascending broadening wedge is a surge from an initial buying impulse, driving the price higher. Momentum traders follow the initial impulse further pushing prices up.

Contrarian traders judge the price to be trading above its intrinsic value, selling and thus creating a decline in prices. However, before the decline reaches the previously established low, certain market participants buy again. These participants can be composed of initial buyers, accumulating positions, or late traders seeing the potential to buy at a better price. This allows the creation of a new impulse, with only a divergence left.

This scenario eventually repeats itself with increased volume, causing impulses and retracements of higher magnitude reinforcing a positive feedback loop until the price is judged overbought even by initial buyers.

5. Other Observations

The amplitude of the cyclical variations within a broadening wedge increases over time, thus potentially highlighting volatility clusters in higher time-frames.

Another interesting observation that can be made is that prices within a broadening wedge are subject to heteroscedasticity (variability is not constant, it increases inside a broadening wedge), while prices inside a channel are homoscedastic (variability remains constant). This concept is inherent to regression analysis.

6. Conclusion

In this post we described broadening wedge patterns in depth. We have highlighted partial rises/declines as well as how the measure rule applies to such patterns. We then focused on showing how market participants act during the formation of broadening wedges.

Note that unlike triangles patterns we did not find a significant amount of studies mentioning such patterns, nor any agent models developed to describe their occurrence.

7. References

(1) Bulkowski, T. N. (2021). Encyclopedia of chart patterns. John Wiley & Sons.