Stock Chart Pattern
The rectangle stock chart pattern is quite easy to spot on a stock chart. It also shows us support and resistance areas. This pattern can offer us trading opportunities on the upside as well on the downside.
Learning this pattern not only helps you in understanding chart patterns. This pattern will open your mind to the combination power of pattern with support and resistance.
When you look at the above picture of this pattern, you will notice that the pattern is rangebound. That is why it is often called a trading range or a congestion area.
For there to be a valid rectangle, there must be at least two equal reaction highs and two equal reaction lows. The highs and lows do not need to be exactly the same but they must be close.
This pattern is usually viewed as a consolidation period in an existing trend. The stock will usually continue in the same direction of the previous trend. However, we need to look at the direction of the breakout for a confirmation.
The breakout occurs when there is a decisive close outside of either the upper line or the lower line. If the stock closes outside the upper line, that will be a bullish breakout. On the other hand if it closes outside of the lower line, it will be a bearish breakout.
- This stock chart pattern can last from a month to a few months. The longer the pattern is, the more significant the breakout will be.
- There is no fix criteria for the volume. However, volume can offer a clue on the direction of the breakout. In your chart pattern education, you would do well to remember that volume plays an important part in trading and investing.
In this pattern, if volume is heavier when the stock rallies and lighter when it declines, then the stock will probably breakout to the upside. If the volume is heavier on the downside and lighter during the rallies, then the stock will probably breakout to the downside.
- We can estimate the breakout target by measuring the height of the pattern and projecting it from the breakout.
How to trade the rectangle
There are quite a number of ways to trade this stock chart pattern.
- You can buy the dips near the bottom of the pattern(support) and sell near the resistance. For those who short stocks, you can short near the resistance and cover near the bottom (support). Sometimes the stock does not reverse at the support or resistance but breaks out. When this happens, the trader can quickly exit his/her position and initiate a new position playing the breakout. Oscillators are very useful in a trading range.
This stock chart pattern can offer many trading opportunities on the upside and downside. However, the trader or investor need to be careful that the rectangle pattern does not become a reversal pattern like the triple top or triple bottom.
- You can also buy the breakout when the stock closes above the upper trendline on heavy volume. For those who short, you can short the breakout to the downside when the stock closes below the lower trendline on heavy volume.
- Sometimes after a breakout, the stock will reverse and go back to the upper line (for upside breakout) or lower line (for downside breakout). The volume should decrease on a return to the lines. This offers a second opportunity to get in. This is a lower risk trade as the lines will become a new support (for upside breakout) or a new resistance (for downside breakout).
- Some traders will treat the rectangle pattern as a continuation pattern of the prior trend. If the prior trend is up, they will anticipate that the breakout will be to the upside. Thus, they will buy every dip(support) of the pattern. This also works if the prior trend is down. Thus, they will short at the top(resistance) of the pattern.
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