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The broadening wedge is a mysterious pattern. While it can be extremely profitable if correctly executed, it can easily play tricks on you if you aren’t careful.
One possible explanation for this trickery is that it occurs less frequently than its sibling, the narrowing wedge. Therefore our minds aren’t as conditioned to spot these formations much less profit from them.
Furthermore, there are attributes about the broadening wedge including its measured objective that differ from a narrowing pattern, which often confuses traders.
Whatever the case, today’s lesson will get to the bottom of it and help clear up any confusion you might have.
In this post, you’ll learn how to identify the most profitable patterns, my two favorite entry methods, and a stop loss strategy that won’t let you down.
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I’ll also show you how to determine a measured objective, which will help you book more profits and know when to stay on the sidelines.
Let’s get started!
The broadening wedge pattern is similar to the upward and downward sloping flags in that it represents exhaustion by either buyers or sellers.
The structure can form sideways without a clear directional bias or in an ascending or descending fashion.
Unlike its inverse, the narrowing wedge, the broadening wedge “fans out” from left to right.
While it is a consolidation pattern, it doesn’t represent what we often refer to as “healthy” consolidation. Instead, it signals that buyers or sellers are becoming exhausted and that a reversal of some sort is the likely outcome.
The image below illustrates the characteristics of the formation.
Notice that we have a support and resistance level as well as the price action that forms the consolidation. What makes it a “broadening” pattern is, of course, the fact that the two levels are further apart at the end than they are at the beginning.
These characteristics are the same regardless of whether the wedge forms at the bottom of a downtrend or the top of an uptrend.
On that note, when it comes to the Forex market, I’ve noticed that the broadening wedge develops at the upper end of a range far more often than at the bottom.
With this in mind and for purposes of this lesson we’ll be referring to the formation as a bearish reversal. But know that it can also trigger a bullish reversal if found at the bottom of a range.
Before we move on, let’s take a look at the broadening wedge in action.
The NZDUSD 1-hour chart above shows a wedge at the top of a range. Shortly after closing below support the pair declines by 104 pips, which is the profit potential that we’re after.
Whenever we talk about wedge patterns, it’s important to differentiate between broadening versus narrowing formations.
Here’s how I define the two:
Often recognized as a reversal pattern that occurs after an extended move up or down where the price action “fans out” from the starting point.
Typically a continuation pattern but can sometimes trigger a reversal. The formation usually occurs after an extended move up or down where price “coils” before eventually breaking out.
One significant difference between the two is that the narrowing wedge has a definable end point whereas the broadening wedge does not.
However, both are considered terminal patterns and both represent consolidation after an extended bullish or bearish move.
Like every trading strategy we use here at Daily Price Action, trading broadening wedges takes patience. I would argue that these price structures require more patience than some of the other strategies and patterns we utilize.
Why is that, you ask?
It’s because broadening wedges are less common than their narrowing counterpart.
On average, you may only find one tradable wedge pattern each month. And that assumes you’re consistently scanning for these formations and trading a couple of dozen currency pairs.
Not only does it take patience to spot a favorable pattern, but it also takes an extra dose of patience to wait for the pattern to confirm and secure a good entry.
Let’s talk about these two now.
The very first thing that needs to happen before you should even think about trading one of these patterns is a confirmed break. There’s a big difference between a market that temporarily dips above or below a level and one that breaks a level.
The difference between the two may seem insignificant, but this one small detail can drastically improve your trading.
Once we remove all the technical jargon, it becomes quite simple. A break is confirmed when a market closes above or below a key level.
That’s all there is to it.
The time frame varies depending on how you approach a technical level or pattern.
For example, a broadening wedge pattern on a 1-hour chart would require a 1-hour close beyond the upper or lower boundary.
Likewise, a structure that’s developing on the daily time frame would need a daily close beyond support or resistance for confirmation.
Pretty straightforward, right?
Now, if you need more evidence before pulling the trigger, simply wait for a retest of the broken level before considering an entry.
With that said, over the years I’ve noticed that the broadening wedge is unlike many other price structures in that they don’t often produce a full retest of the broken level.
In many cases, the wedge will confirm, and the market will either continue in the direction of the break or retrace half of the move. But a full retrace of the broken level is rare in my experience.
Let’s take a look at a couple of examples.
First up is the NZDUSD 1-hour chart that I presented at the beginning of this lesson.
Notice how we’re entering on a retest of a former intraday swing low. This retracement helped offset the risk to some degree by allowing us to secure a favorable risk to reward ratio.
More on that topic shortly.
The second method is a bit more aggressive and offers a lower risk to reward ratio. As such, it isn’t my preferred way of entering these reversal patterns.
But before we get into the entry strategy and stop loss placement, let’s outline the attributes of this particular structure.
The USDCHF 4-hour chart above shows an aggressive rally that stalled into a broadening wedge. The pattern triggered a sharp 270 pip decline over the next few sessions.
Now that we’ve set the stage let’s look at how we could have taken advantage of this reversal.
Notice that we aren’t waiting for a retrace. Instead, we’re entering short as soon as we have a confirmed breakout.
Remember that a confirmed break is when the candle closes beyond support or resistance. In the case of the USDCHF chart above, that’s a 4-hour close below support.
But there’s one problem with this setup. Because the pair never retraced a portion of the initial breakout, the risk to reward ratio was questionable.
In fact, there’s a good chance that it would not have met our mandatory 1:2 risk to reward ratio. I’ll explain why in the next section.
So how do you choose which entry method to use?
That’s really up to you. Each has its advantages and disadvantages. As I always say, the “best” approach is the one that works for you.
There are two methods you can use to identify profit targets when trading a confirmed broadening wedge.
The first is to use horizontal support or resistance levels to time your exit. These are the areas which you have predetermined to be of value, thus taking profit at any one of them makes perfect sense.
The second way is to use a measured objective. Just like the narrowing wedge, a broadening wedge has a built-in objective we can use to identify a profit target.
Here’s how it works:
Notice how I took the height of the entire pattern and measured an equal distance from the breakout. In this case, the height was 93 pips and the market ended up moving a total of 104 pips.
While not an exact science, as you can see from the NZDUSD chart above, this method of finding a profit target can be very useful.
Whether the objective is higher or lower depends on whether you’re trading a bullish or bearish broadening wedge.
So which method is best?
Personally, I prefer a combination of the two. This way I get the best of both worlds.
Here’s what I do…
First, I’ll take a measurement of the pattern to find the measured objective. If that distance lines up with a predefined horizontal level, that’s where I’ll set my order to take profit.
If it doesn’t match up with one of these areas, I’ll choose the closest support or resistance level without exceeding the measured move.
The NZDUSD chart below illustrates where I set my take profit and why.
As you can see, there was a key horizontal level that was just a few pips higher than the 93 pip objective. This combination provided an ideal location to book profits.
Now do you see why the USDCHF bearish reversal that we reviewed in the last section was flawed?
Although it was an impressive move, the fact that prices didn’t retrace a portion of the breakout meant the risk to reward was less than favorable.
The height of that pattern was 100 pips. Our entry (shown above), was already 48 pips below wedge support. Remember that we were entering as soon as it confirmed and without waiting for the retest.
This alone was a red flag that the entry method wasn’t going to offer us a favorable enough risk to reward.
And because the pair didn’t retrace a portion of the 4-hour candle that broke support, I would have sat this one out.
As you can see from the chart above, the 100 pip measured objective lined up with a key horizontal level. However, the initial target was too close to our entry to justify a position.
And while the market did, in fact, continue lower, we wouldn’t have known that at the time.
Using critical support and resistance on their own can be an extremely effective way to trade any broadening wedge. However, when you combine them with a measured objective, you’ll be able to place profit targets with confidence.
Give this combination a try the next time you come across a one of these formations. I think you’ll be surprised at how often the objective matches up with a predefined level of support or resistance.
If you want to identify and profit from broadening wedges, it’s important to set yourself up for success.
Let’s take a look at three factors that can make all the difference.
The first and most important thing to consider are the time frames you will use. While I occasionally trade from the 1-hour chart, I conduct 90% of my trading from the 4-hour and daily time frames.
By staying away from the lower time frames (anything below one hour), I avoid the intraday “noise” that can result from news events and other unscheduled risks.
Also, one thing you’ll find when you make the transition to a higher time frame is that false breaks become a rarity, at least compared to a 5 or 15-minute chart.
Last but certainly not least is the fact that a higher time frame gives you just that – more time. This translates to less anxiety and frustration because you aren’t rushing to determine a favorable target or to place a trade.
All of this makes for a much smoother and less stressful trading environment. And in an industry where mental discipline is 90% of the battle, the combination of less stress and more confidence can be a game changer.
How many trades do you take each month?
This question will fetch a variety of answers depending on your strategy, time frames utilized, risk to reward and several other factors.
Although I don’t know anything about you or the way you trade, I would be willing to bet that you’re overtrading.
That may sound like a bombastic accusation but hear me out…
If you’re using the higher time frames (4 hour and daily) and taking more than ten trades a month, there’s a 90% chance that you’re trading too frequently.
In other words, you’re choosing quantity over quality rather than the other way around.
I’ve been where you are now. At one point I was taking over thirty trades each month. At the time I honestly thought my approach was conservative.
The truth is I didn’t have a clue what it means to trade quality over quantity.
You see, when it comes to the “A+” setups—those of the highest quality—there are only so many that materialize within a 30-day period. In my experience, that number ranges from three or four on the low end to maybe ten during an active month.
So, before adding the broadening wedge pattern to your trading arsenal, it’s important to set the appropriate frame of mind. Don’t expect to find these setups every week or even every month.
In some cases, it can take months for one to develop that’s worth trading. But with the right risk to reward ratio, the potential reward can be well worth the wait.
As with everything you do while trading the Forex market, it’s important that you track your results both good and bad.
In fact, I would argue that keeping track of your mistakes is more important than your successes. This is because there is often more to learn from your wrongdoings or bad habits than those aspects of your trading that need little to no work.
But it’s boring; I get it. And tracking results isn’t going to make you money, at least not directly. Perhaps this is why it’s one of the most overlooked steps of becoming a successful Forex trader.
But make no mistake. Although it’s a bit tedious and even boring at times, good record keeping is a crucial step of becoming a profitable trader.
And it isn’t enough to do it for a few weeks or months. It has to be instilled in everything you do. It’s a process which means it never ends.
Be sure to see my post on the 5-step blueprint for navigating the Forex market where I dive into some of the data points you should be tracking.
Broadening wedge patterns don’t come around often, but when they do you’ll want to pay close attention as they provide an excellent way to spot exhaustion within a trending market.
The best patterns tend to form on the 1-hour chart or higher and occur after an extended move up or down. With that said, it may be a good idea to stick to the 4-hour and daily time frames if you aren’t yet consistently profitable.
Like all of the technical patterns we trade, it’s important to wait for the market to close above or below resistance or support respectively. Only then can you label the structure as confirmed and thus tradable.
A retest of the broken level offers the best risk to reward ratio but keep in mind that this can also cause you to miss the entry.
Be sure to use a combination of horizontal support or resistance and a measured objective to add a degree of confidence when setting your profit target.
Do you trade broadening wedge patterns? Did you find this lesson helpful?
Share your experience or ask a question below and I’ll be sure to respond.
Justin Bennett is an internationally recognized Forex trader with 10+ years of experience. He's been interviewed by Stocks & Commodities Magazine as a featured trader for the month and is mentioned weekly by Forex Factory next to publications from CNN and Bloomberg. Justin created Daily Price Action in 2014 and has since grown the monthly readership to over 100,000 Forex traders and has personally mentored more than 3,000 students.Read more...
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