| Rectangles can
occur in any time frame and any market you are
following. As with many chart patterns the
pattern is in the eye of the beholder. I have
found that some traders are better than others
at identifying chart patterns. It may take some
time before you can spot the most common
patterns. The rectangle contains price
movement between two points in a rectangular
shape to which we add lines to signify the upper
boundary and lower boundary. These lines should
be horizontal. Slanted rectangle will most
probably fall into the realm of ''Flags'', which
we will discus in another lesson.
The top line should connect at least two bars
and the bottom line should connect at least two
bars. As most markets are in congestion most of
the time rectangles are fairly common.
It is not necessary to draw the top and lower
lines at the extreme of the congestion points
but rather make sure the lines contain at least
95% of the congestion area. The longer the
rectangle continues the more important the
breakout.
To help identify a valid breakout there
should be an increase in volume on the day (or
time period) of the breakout. The breakout can
occur in either direction but if you are in a
defined up trend then an upside breakout is
favored and vise versa for a down trend. If I am
in a defined trend then I tend to view this
pattern as a continuation patter unless it
starts to break the other way.
There are a number of ways to trade the
rectangle. You can buy or sell the breakout as
it happens or you can wait to see if there is a
pullback to the neckline (see charts). Once you
have defined the rectangle you can also buy and
sell at the boundaries of the rectangle. I
prefer to buy at the lower boundary if in an up
trend and sell at the upper boundary if in a
down trend. This can be a very effective trade
as the risk is small. If you sell at the upper
boundary then your stop loss can be close to the
boundary and vise versa for the long trade at
the lower boundary.
If you sell the breakout place your
protective stop inside the rectangle and do the
same for buying the upside breakout. You can
also measure the distance between the upper and
lower boundaries and project the distance
forward to get an indication of the size of the
next move. If the distance from the upper to the
lower boundary were 20 ticks then I would expect
the next move to be at least 20 ticks.
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