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Most deals are waiting. I know you don’t want to hear this. You want action, you want attention, you want suspense. Heck, the subject is called price “action,” so there must be something actionable, right?
Well, the thing is, if you’re not prepared for volatility when it occurs, there’s a good chance you’ll end up catching up to it once it does. At least most traders do, which is why many retail traders end up buying high or selling low – they are caught in the excitement of a fast market and don’t want to miss out (FOMO), but there are still signs that they Don’t know exactly what to do.
This is where digestion can help, I’m not talking about a balanced breakfast. I’m referring to the trade setup and the fact that the market cycles like most people. As the market consolidates these new higher/lower prices, there is usually a bout of activity followed by a digestion pattern. This is just one of the reasons why traders long before a big rally will try to take profits. The simple act of some traders taking profits can lead others to do the same out of fear of giving up their profits. We might even include contrarians as they try to build new shorts from new highs – all of which could be associated with a sharp drop in price as there is an oversupply at this new higher price.
It’s just digestion, and it happens on all time scales in various ways. But as they say, the devil is in the details, and digestion can often take the form of price action patterns that traders can then use to generate trade setups.
The Triangle
A triangle pattern consists of horizontal planes and trend lines. That’s it. We have a full article on ascending triangles that focuses on how horizontal resistance levels align with higher lows, such as those produced by a bullish trendline, to form the pattern. On the other hand, the descending triangle has horizontal support as well as a bearish trend line showing lower highs.
The key here is to reduce marginal impact. Let’s tell the story from the perspective of massive support, and let’s look at an example for USD/JPY.
USD/JPY hit a swing high of 116.35 in early January 2022. The pair has pulled back less than 300 pips, but a few months later, buyers were once again condemned at the same price. Another retreat followed – but this time the sellers couldn’t get as far as they did the first time.
This is an example of resistance at 116.35 having less impact on the second test as buyers have entered the area. This created an ascending triangle of horizontal resistance and a higher low, which you can see on the right in the chart below.
USD/JPY daily chart
In the third test of this level, there are no more short orders, at least not enough to deter buyers. Sellers are not doing as well as buyers, driving a positive upside breakout from this formation.
The main difference between a triangle and a wedge is horizontal support or resistance. In a triangle pattern, this is a level that is expected to be broken with sufficient persistence by buyers (resistance) or sellers (support).
On the other hand, a falling wedge indicates that sellers are very aggressive near resistance or highs and passive near lows or support. This can usually be established from a major support or resistance level as sellers try to avoid selling near this key support level. But this is deductive in itself, as this passive nature usually leads to a reversal near a low or support level, as we saw in the wedge article.
Chart prepared by James Stanley; USD/JPY daily chart, Feb 2021 – April 2022
Difference from the Wedge
The main difference between the triangle and the wedge is the horizontal support or resistance. In triangle formations, this is a level that’s expected to be broken with enough persistence from buyers (for resistance) or sellers (for support).
The falling wedge, on the other hand, is showing that sellers are really aggressive near resistance or at highs while being passive around lows or support. This can often build in due to a major support or resistance level, as sellers look to avoid selling near that key support. But, that itself is deductive, as that passive nature near lows or at support can often lead-in to a reversal scenario, as we look at in our article on the topic of wedges.
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