3.14 Trading with Rectangle Chart Patterns
A rectangle pattern is typically a consolidation pattern and is an area where the price is trading in a range confined between two approximately horizontal lines which represent support and resistance respectively.
Normally, trending prices will take a breather in this zone and during this time the price will move up and down indecisively between the top band of the rectangle (the resistance) and the bottom band (support).
The pattern may be formed after an up trend or after a decline. Rectangles are normally a continuation pattern and hence in either case the price may be expected to break out of the rectangle in the direction of the original trend.
Why Rectangles are a Continuation Pattern?
Unlike any other chart pattern, the highs and lows of a rectangle remain almost at the same levels. This fact indicates that neither bulls nor bears are having a winning hand. The trend is just taking a pause but bullish and bearish sentiments are balancing each other without any particular side winning. This makes the ongoing trend to continue once a breakout takes place.
Bullish and Bearish Rectangles
If the trend preceding the rectangle was bearish, and the price broke down out of the rectangle in the same direction, the pattern is called a bearish rectangle. Conversely, if the rectangle occurred during an up trend, and prices broke out to the upside, the pattern is a bullish rectangle.
Rectangle Pattern Breakout During an Uptrend
As the above Forex chart shows, the price action was in an uptrend. There was some consolidation and then the price-action fell into a rectangle pattern. Subsequently there was an upward breakout which resulted in the resumption of the trend.
Rectangle Pattern Breakout During a Downtrend
The above Forex chart shows two consecutive rectangles. After the price-action broke out of the first rectangle, it continued with the downtrend but soon it entered in another rectangle pattern. This one proved to be a short one and another breakout resumed the same trend.
Generally, once the price breaks out of the rectangle, it may be expected to make a move that will be, at a minimum, the height of the rectangle itself. This stands true for both bullish and bearish rectangles.
How to Predict Breakout Direction When There is No Trend?
Rectangles do form when there is no ongoing trend in the market. The following chart shows one such case:
The above Forex chart again shows two consecutive rectangles. The first one which is shown with the red support and resistance lines formed when the market was running without any trend. It was just a volatile market. How do you predict possible breakout direction in such case? Well, it is not as difficult as it may sound. Simply observe other tell-tale signs to assess the situation. The resistance line of the first triangle failed to retest the previous high and this was a sign of bearishness. There was no downtrend but the bearish sentiments were evident and that made the possibilities of a downward breakout stronger - and that's exactly what happened.
How do we trade rectangles? Two ways – inside and outside.
One way to trade a rectangle, from the inside, is to buy near the lower horizontal support line and sell at the upper resistance level. This takes advantage of the price moves inside the pattern and depends upon the fairly reliable support and resistance lines.
The other way, from the outside, is to catch the price action once prices have broken out of the rectangle. If the price is breaking down, place a short order just below the bottom line and hope to catch some meaningful pips (height of rectangle…remember?). If the price is breaking out from a bullish rectangle, place a buy order just above the resistance top line.
- Trading with Rectangle Pattern