One of the easiest to spot and certainly common chart formations is the Rectangle Pattern. The pattern will repeat over and over throughout a trend, and simply means that the markets are taking a rest before the next move up or down. Quite often, they are continuation patterns, but there are specific rules one should follow before taking that trade.
The rectangle is formed when you have two specific levels where the market bounces from. In other words, the sellers are in control at the top of the pattern, while the buyers are in control at the bottom. The resulting back and forth action produces a rectangle-shaped pattern that is instantly recognizable, especially on higher time frames. It is because of this that the pattern tends to be widely used and loved by traders around the world.
The rectangle also tells us quite a bit about the markets themselves. The rectangle simply shows that there is a subtle balance in the market, and that the buyers and sellers both have equal conviction about the general area. The rectangle can go on for far much longer than people suspect, and it is because of that some traders don’t like the pattern. But the one thing those traders don’t take into account is the fact that it isn’t the pattern that is traded so much, (Unless of course it is a massive rectangle, in which you can simply sell at the top, and buy at the bottom – at least until it stops working.) but rather the breaking of the pattern that they should be interested in.
The rectangle pattern can be traded in a few ways. In extreme circumstances – you can trade back and forth within it, but only on larger rectangles should this be attempted. You need to have a large range in order to have a reasonable opportunity to profit.
However, the most common way to trade the rectangle is to wait for the breakout of the range. The rectangle is then measured for its height, and the number of pips is then added/subtracted (depending on the direction of the move) to the level where the breakout occurs. This gives you a potential target for the trade. For example, if the rectangle is 120 pips high, upon the breakout to the upside, you would add 120 pips to that price for a projected target.
The more conservative trader will not only wait for a breakout, but also will wait for a retest of the previous support or resistance level. This harkens back to the old adage that “what was once support becomes resistance, and vice versa.” As you can see on the chart above, that area is circled in red.
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