How can I recognize a rectangle chart pattern?

In technical analysis, a rectangle formation is a price pattern that frames significant support and resistance. The rectangle pattern is from the work of Richard Schabacker, who more or less wrote the bible on technical analysis. It hearkens back to a time when charting was done by hand using graph paper and manual calculations. Where modern technical analysis is based on indicators, technical analysts in the past believed that price patterns would be repeated, and thus were useful in predicting future price movements. Traders recognize rectangles as continuation indicators, signaling a pause in a trend. It’s one of the more easily recognized patterns, formed by two parallel lines connecting highs and lows. Rectangles are also called trading ranges or consolidation zones. The pattern is completed once a breakout has occurred; unfortunately, it isn’t usually possible to determine beforehand which way the breakout will go. Other things to keep in mind with rectangle patterns:
  • Because rectangles are considered continuation indicators, a trend must be present of at least twomonths’ duration.
  • Volume doesn’t follow traditional patterns, as in a symmetric triangle. Volume may decrease as the rectangle develops, especially as price bounces between support and resistance levels, but it rarely increases. When the breakout occurs, however, you should see expansion, which confirms the breakout.
  • A rectangle typically lasts for a period of three weeks to many months. If the pattern is of short duration, it’s generally considered a flag, not a rectangle.
  • When a breakout occurs, it’s typically at least the size of the rectangle pattern. In other words, if the rectangle covers a range between $45 and $50, the breakout will generally be at least $5 in the trending direction.
  • A basic rule of technical analysis applies to rectangle patterns, in that once a line of support or resistance is broken, it will return to the breakout point and the line of support becomes the line of resistance and vice versa.
In the example above, you’ll see an established but not too mature downtrend starting in January 2018, and then the price begins to bounce between $135 and $150 for about five months, with low trading volumes. When the breakout occurs, there is a confirmatory spike in volume, and the price pushing against the previous support level, which has now become resistance, before plunging again. You’ll also note that the range of the rectangle, about $15, was actually more than doubled before the trend reversed again. A smaller rectangle pattern can also be seen in April and May 2017. There are two basic strategies if you want to trade on a triangle. The first is to range trade within the triangle, buying at support and selling at resistance, or conversely, shorting at resistance and covering at support. You do need to set tight stops to mitigate risk if you are shorting in case the breakout goes against you. The second is to wait and trade the breakout, which again, is confirmed with an uptick in volume.