Narnolia Financial Advisors
Basics of Technical Analysis: Part 16
The rectangle is a classical technical analysis pattern described by horizontal lines showing significant support and resistance. Rather than modern technical analysis, which relies on indicators, such as moving average convergence divergence (MACD) or Relative strength Index (RSI), many technical analysts assumed that price patterns repeat themselves over the time and are more reliable than indicators.
What is ‘Rectangle’ Pattern?A rectangle is a chart pattern formed when price are bounded by parallel support and resistance levels. This pattern is where supply and demand are in approximate balance for an extended period of time.In any case, it is a pattern which shows traders indecision, one in which the bulls and bears are approximately equally powerful.
Figure .1.Illustration of RectangleChart Pattern
Many of the price patterns are based on geometrical figures, some of them are ascending, descending and symmetrical triangles, pennants and wedges and rectangle.Rectangles are sometimes referred to as: -
• Sideways movementCalculations of target and stop loss
Figure .2. Calculations of Target & Stop Loss in Rectangle Pattern
Formation of Rectangle Pattern•> The rectangle formation mirrors a degree of insecurity among investors, where buyers and sellers are pushing the stock price sideways. When the stock breaks through former tops or bottoms, this indicates expectations for the direction to come and gives good trading opportunities.
•> For a breakout to be considered validit should be on a closing basis; howeversome traders apply a filter to price (2%) while considering breakout.
Types of Rectangle Pattern
Horizontal lines drawn on the chart denote significant support and resistance, however depending on existing trend we have majorly two types of pattern. These formations are regular, find detail explanation below.
1) Bullish Rectangle PatternThe bullish rectangle is a continuation pattern that develops during a strong uptrend.Bullish rectangles are useful while buy and hold trading strategies.
Figure .3.Sketch of Bullish Rectangle Pattern
Figure .4.Illustration of Bullish Rectangle Pattern
2) Bearish Rectangle PatternThe bearish rectangle is a continuation pattern that develops during a strong downtrend. Bearish rectangles are useful while short and cover trading strategies. The bearish rectangular pattern is the mirror image of the bullish pattern.
Figure .5.Sketch of Bearish Rectangle Pattern
Figure .6.Illustration ofBearish Rectangle Pattern
Trading the Rectangle Pattern
1> Buy at support horizontal line and sell at resistance horizontal line.
2> Trade the breakout; buy above breakout point and short sell below break down point. As with all technical patterns, this breakout of rectangle should ideally occur on above-normal volume.
Volume and Rectangle Pattern
Volume can also add further insight while trading these patterns.Volume is invaluable when confirming any of the two types of rectangle pattern break out to upside or downside. If volume isn’t present alongside patterns breakouts, then the resulting trading signal isn’t that reliable.
It is observed that false or fake breakout of pattern is witnessed in absent of volume while pattern completion. Nevertheless observing volume, price action and indicators while breakout of rectangle, will keep trader away from false break outs.
Conclusion•> The rectangle formation is a typical example of a "price pattern" in technical analysis.
•> The pattern has completed when price breaks out in the direction of the prevailing trend, at which point it will likely continue in this direction.Disclaimer: The author is Head - Technical & Derivative Research at Narnolia Financial Advisors. The views and investment tips expressed by investment expert on moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.