In conventional technical analysis they call it “wedge”. In Elliott Wave analysis we call it “ending diagonal”. Both terms imply the same thing – reversal ahead, but since we work with the Wave Principle, we will refer to it as an ending diagonal. So, what is it? On the example chart below you can see an idealized version of the ending diagonal with all its characteristics.
Ending diagonals consist of 5 waves, labeled 1-2-3-4-5. Each wave subdivides into threes. Waves 1 and 4 overlap in price. Wave 3 can not be the shortest among waves 1, 3 and 5. Wave 1 is usually the longest, but not necessarily. Wave 5 of an impulse and wave C of an A-B-C correction are the places, where you should be looking for an ending diagonal. Since it is the final movement of the sequence, after an ending diagonal prices are expected to go back to the level, where the pattern had started. A real-life example of an ending diagonal with all its features is given on the chart of AUD/USD below.
In this case it is in the position of wave 5. Its structure and sub-structure are also visible. You can see how each wave is constructed of simple or double zig-zags, which is one more indication that the larger trend is exhausted. Note that wave 5 of the diagonal breaks above the upper line for a while. This is called a throw-over and represents the extreme optimism, which traders and investors usually demonstrate, when a major top is forming. And just as the science of Socionomics postulates, when an extreme in psychology is reached, it is time for a change. And the change here is that AUD/USD lost nearly 40%, crashing from 0.9950 to 0.6000 in just 4 months. Now let’s move to another example, this time of an ending diagonal in a downtrend.
Gold finished 2013 with a perfect ending diagonal in wave C. The pattern remains the same – the structure, the wave count, the form. The only difference is in its direction. That ending diagonal made its final bottom at 1180. After that, a strong rally has begun, adding some 210 $ to the value of the yellow metal. On the chart below you will see how the ending diagonal fits into a complete impulsive wave.
The whole impulse has been developing quite normally until wave 5, which became choppy and overlapping, thus giving us a sign of a nearing change in trend direction. You can see what happened next.
And our final chart is the most recent one. The ending diagonal in EUR/CAD.
There are three ways to trade an ending diagonal. The most aggressive one is to open a position near the end of wave 5, with a stop-loss order at the level, where wave 3 would become the shortest among waves 1, 3 and 5. The second approach is to open a position, when price breaks the line, connecting waves 2 and 4. And the most conservative way is to wait until the end of wave 4 is taken out. In all cases the minimum target is the end of wave 2 of the diagonal.