Broadening wedge chart formation

One of the less common but still powerful chart formations is the broadening wedge. It’s rather the opposite of the consolidating triangle, where the support and resistance boundaries force the price action into a tightening apex until there’s nowhere left to go except out.

Although a triangle is generally considered a continuation pattern, an ascending triangle doesn’t always break above resistance and a descending triangle doesn’t always break beneath support.

Broadening wedges, on the other hand, are shaped rather like a megaphone, with the support and resistance lines diverging. In stock trading, there should be at least three touches of the lower support boundary and two touches of the upper resistance to confirm the pattern. But most importantly, a broadening wedge serves as a reversal signal for a price movement that the market has decided should never have happened.

•    An ascending wedge has both support and resistance lines sloping higher, like a megaphone aimed upward. Although it’s most common in a bull market, an ascending wedge may occur at any time. The stock’s price rises, hesitates (perhaps forming a double top or head and shoulders), and then returns to its original level.
•    A descending wedge slopes downward with both support and resistance lines. This pattern is most common in a bear market, but again, that’s not exclusive. The price falls, pauses and perhaps forms a double bottom or inverted head and shoulders, and then reverses back to its original price level.

A pullback and re-testing of the broken boundary is common with the broadening wedge formation. Although volume isn’t generally examined, over half the time it rises during the megaphone phase and falls off during the reversal. The rest of the time volume holds during the megaphone and rises during the reversal.

When trading a broadening wedge, the usual strategy is to enter the market in the direction of the megaphone on the third touch of the lower support boundary. Exit that trade at the break, and once the re-test is past, re-enter the market in the opposite direction. With both ascending and descending wedges, the price target is the base of the megaphone, or right back where it started.

Below is the chart of AGL Energy Limited (AGK), showing an ascending wedge that developed earlier this year:

Note how the support and resistance boundaries of the rally diverge, illustrating its instability. The third touch of the lower boundary occurred in early April, at the 15.00 level and unfortunately after much of the rally was past. However, a slight rise in volume over the succeeding few days shows that some traders did enter the market long at that point.

In mid-April the rally proved unsustainable at 15.69 and the price action soon broke beneath the support line. It re-tested the boundary from beneath, as resistance, before conceding defeat, and then the price rolled off the table on rising volume, returning to its original level at 13.80 by the end of May.