Descending broadening wedges are nonparallel price trend lines that slope downwards in a stock chart while broadening out. They depict a reversal from a bearish trend and open the way for a bullish upward breakout. The best patterns have long formations with a falling volume trend. This volume increases with time, although it begins at the bottom of the chart, especially in the annual price analysis.
Figure 1: Descending Broadening Wedge (DBW)
The wedge-like formation broadens and consolidates out (in figure 1) in a downward direction as the price trendlines hit a sharp reversal upwards. Volume is seen to increase as the price action continues downwards. It is irregular as the prices rise above the upper section of the trendline. Figure 1 shows that the wedge forms in an intermediate-term change in the price trend and not in a generally bearish market.
The price moves in a bullish pattern from June to September. Prices rise from $16 to $27. The wedge forms in a short-reversal as prices trend lower after the downward breakout at $26 mid-August to September before rising again to $26 in October. The wedge begins from mid-September to mid-October before the sharp upward breakout begins.
Identification of the DBW
The descending broadening wedge (DBW) looks like a cone-shaped nonparallel trendline that is tilted or moving downwards. The slope downwards as the wedge continues to move downwards as the short bearish trend continues. The lower line is slightly steeper as they broaden over time. It is not parallel, thus cannot be termed horizontal.
Figure 2: Bitcoin/ US dollar 1-month Analysis Chart- Practical Example
2. Downward trendlines
The two opposite trend lines are required to have two distinct touches on either side as the downward movement continues—the volume of the price actions increases as the wedge forms within the pattern.
As earlier indicated, the breakout is upward, especially if the wedge-formed from a downward slope. It is mostly opposite the direction of the previous price trend.
The previous price trend, in this case, is a partial or short-term decline. The decline must begin when the prices hit a top trendline (in a bullish run) and then turn downwards. The partial decline precedes an upward breakout.
A look at figure 2 shows that in 2021, the price of Bitcoin (BTC) against the dollar reached $42,062.87 on January 8, 2021. It dropped to $30,0084.60 on January 11, 2021. The BTC/USD trading began the partial decline when it hit a high of $40,283.24 on January 14, 2021. The lower trendline of the wedge-like price action began at $34,259,89, while the upper trendline was at $39,051.19.
The descending broadening wedge (DBW) runs from January 16, 2021, to January 27, 2021 (11 days) before the upward breakout begins. After the trader spots the partial decline and the DBW, there is a high possibility that the downward price trend will soon be cut short as the commodity prepares to hit an upward run.
We should also consider that the previous price pattern can also be bullish before the descending broadening wedge is formed. In this case, the DBW will indicate a reversal towards a bearish trend (as seen in the figure below).
Figure 3: Bullish trendline before the DBW is formed
However, the formation described above (in figure 3) is not perfect, and the trader may term it as a failure. The movement of the prices is limited to 5% after the breakout occurs. The stock’s price will move in the opposite direction in most cases as it meets overhead resistance.
The descending pattern mostly appears in a short-term or intermediate-term bear or speculative market such as cryptocurrencies. It describes a reversal in many instances as compared to continuation trends.
Figure 4: DBW- Bullish Reversal
In figure 4, the price of Bitcoin (BTC/USD) dropped to $30,0084.60 at the end of the descending broadening wedge (DBW), but it later rose to an all-time high of $58,284.86 on February 21, 2021.
- An upward breakout that identifies as a continuation will work better than a reversal. In a bull market, downward breakouts signal reversals as compared to continuations. After prices reach their ultimate highs, on average, they tumble 20-33%. For example, after prices reached an all-time high of $58,284.86, they decreased 21.73% to $45,622.13 on February 26, 2021. The trader should be prepared for further decreases as it may reach a low of 40% before it begins to rise again.
- Further, prices will rise in the range of 50-100% after hitting the ultimate low information of the wedge. After Bitcoin dropped to $30,084, it rose 93% to a high of $58.284 before the end of February 2021.
- The trader should be patient before trading and wait for the closure of the prices after the trendlines. Patience enables the trader to understand the price movement and any fundamental logistics that may affect the trading pattern.
- A partial decline, in most instances, is followed by an upward breakout. The breakout is confirmed if the decline begins from the top trendline. The breakout often reaches annual or all-time highs, as witnessed in the recent rally of Bitcoin.
- Buy when the price reaches the bottom of the trendline (in readiness for an upside) and sell when the prices move to the top of the trendline. This action holds in a broad wedge pattern. You can also sell short at the top of the wedge’s trendline but keep in mind that it is a partial decline, and prices are to rebound.
- Pick different areas of support and resistance (see figure 4) and place stop loss as the trade develops.
The descending broadening wedge (DBW) is a downward formation that projects an upward breakout. Traders watch and target prices based on the wedge formation. To get maximum profit using this formation, the trader should place a stop-loss at a target that will trigger a sale rather than a buy.