Wedge Strategy for option trading: profit or loss?
When considering technical analysis from the standpoint of pattern formation in the charts, then adding some novelty is quite difficult. During the years of surveillance, traders have learned to divide the occurring figures into pivots signaling the reversal of the imminent trend and the patterns of trend continuation. But there are figures in technical analysis, which may indicate both a reversal of the trend and its continuation, depending on the circumstances of their occurrence in the chart. This time we will consider one of these models. Today the figure of Wedge is in the focus of our attention.
To avoid confusion we will figure the points out. In an uptrend two types of wedge can form: rising and falling. Rising wedge looks like a symmetrical triangle and is formed with the help of converging support and resistance lines.
This pattern is considered a reversal figure in an upward chart, because buyers can no longer push the price up after a long uptrend, so for some time the price is in a small corridor; and the trend after breaking the figure down changes its direction.
Unlike the rising wedge, falling wedge in an uptrend indicates the continuation of the trend. Such wedge is no different from the rising evidently, except that its vertex is directed downward and is formed on the upward movement correction. After its formation is finished, the price hits the wedge up and continues to move up North.
Once we figured out the ascending movement, we get down to the descending. Here a self-titled pattern will also mean a possible trend movement reversal. While long-term movement sellers attempt to trade, the level of reached lows will take place, gradually reducing these lows slightly. But the strength of the trend has already run low, and therefore these are the last successes of “bears”. After breaking the resistance by the figure of Wedge upwards, the trend rushes there.
In contrast, the rising wedge in a downtrend will suggest the trader that in the chart we see just a correction and the trend will continue to bound for the same direction. We can identify the rising wedge with the help of the upward vertex of triangle consisting of support and resistance lines. After breaking the support line down, the downward trend will continue to storm new bottoms.
Conclusion: we always purchase on a downward wedge and always sell on the upward wedge; the type of prevailing trend in the market doesn’t matter.
Entry points for the option to purchase:
To make a purchase, we will consider two variants. The first one – in the formation of the descending wedge on a “bullish” trend. We have to track the ending of correction and, when a rising candle closes above the resistance line, purchase a Call option. As the signal filtering, we traditionally offer you to wait for the next candle closing after the breakthrough above resistance line.
Another variant for a Call option will be a breakthrough the falling wedge on a downward “bearish” trend. After forming the figure of Wedge, we wait until its breaking up and conclude an option to purchase the asset. Also, it is wise to use a filter that will protect from false signals and unwarranted losses.
Entry points for the option to sell:
For sale, or a Put option, we will wait for the formation of a rising figure of Wedge, which can also be formed in the uptrend or downtrend. Just as with the Call option, we need to wait for the breakout of the wedge downwards, then you can make a deal. To be safe from a failed transaction, you can enter a contract not only after closing the ascending candle below the resistance line, but either to expect the next candle closing outside the graphic figure.
As already was mentioned above, the graphical figure of “Wedge” is one of the most frequently occurred patterns in the graphs. Therefore, this strategy produces a number of signals. A trader can trace these signals on any graphs, from a minute one to a daily one – it all depends on the style of trading you prefer. Thus, if you are into intraday trading – search for Wedge on the small timeframes and trade intraday. If you rather choose long term and medium, accordingly, study the graphs of more significant timeframes.
The most popular type of option today, traded on this strategy, is the classic option with a fixed expiry date. However, practice displays One Touch options demonstrating excellent results with a set level of possible touch for 10-15 points either above or below the graphic figure. In this case, the option Call or Put can be concluded in the very moment of the penetration of Wedge, without waiting for a candle close outside this figure.
The optimal expiration term for trading on a considered strategy is the period with three candles, after the first candle or two candles close, if the option is bought later on the second candle closed outside the Wedge. Thus, when trading on the hourly graph, in the first case the expiration term will be three hours, and in the second – two. The same rules are followed while trading on the other timeframes.
In spite of the wide range of signals this trading strategy generates, their profitability comes to approximately 70%. That is, you can earn the profits, of course, but to reduce the level of false signals we would recommend using filters in the form of next candle and work with One Touch options instead of classic options, looking back at the instructions described above. Last year test history on one raw material and two currency pairs with the signal filter and touching level for 15 points from breaking the figure could make the level of profitable signals reach 81%. That is, four profitable transactions make up one unprofitable transaction.
A couple of factors, which we have already mentioned – the frequency of the signal occurrence and their not too high accuracy, lead to the conclusion that the option entrance is quite unreasonable with the risk of losing more than 2%. If you accept the risk greater than installed, you can skip a profitable signal on another tool, since according to the laws of money management, the risk of all concluded transactions must not prevail 5% of the whole deposit sum. Preferring 2% risk, you reserve the right to make additional entry to the market with another signal or other assets.
- Goes well with different types of options
- With appropriate adjustments the efficiency of the strategy is about 80%, while with the risk of 2% you preserve the right to make additional entries
- Following the money management laws the entire risk will not outreach 5% of the deposit sum
- It can be easily confused with Pennant
- The profitability of signals is only 70% – you need to use signal filters to make the level of profitability higher
- You can easily miss a profitable signal, besides, the strategy generates a number of signals but not all of them really fit
That’s all for now. Got any questions? Just ask the expert!