The falling wedge is a bullish pattern that begins wide at the top and contracts as the price moves lower and the trading range narrows. The falling wedge can be classified as a continuation pattern or a reversal pattern. For a continuation pattern, the falling wedge will slope down, but the slope will go against the current up-trend. On the other hand, a falling wedge reversal pattern will slope down and trade with the prevailing down-trend. But regardless of either type, the pattern is considered to be bullish for the security in question.
The falling wedge pattern usually spans 3 to 6 months and can provide traders with a signal that the current trend is about to reverse. For the falling wedge to form, it takes at least two reaction highs, with each high being lower than the previous one to form the upper resistance line. Also, at least two reaction lows should be in place, with each low being lower than the previous one to form the lower support line. The upper resistance line should then converge with the lower support line, signalling that there is not enough sellers at the lower prices to keep pace with the slope of the upper resistance line. This loss of selling momentum on each successive low thus gives the falling wedge pattern its bullish bias. As always, the pattern is not confirmed until a resistance level is broken, which, in this case, is the down-sloping upper resistance line.
In the above reversal falling wedge example, the price was in a down-trend when it continued to set new lows at points A and B, with corresponding lower high. But as shown on the MACD, the strength of the selling was suspicious as a positive divergence occurred for the lows around points A and B. Once the upper slope line caught up with the price, there was not enough downside momentum to push the price down any further and subsequently, the price broke above the resistance level around point C. The prevailing down-trend, thus, was reversed to the upside.