Out of all the chart patterns available, the rectangle pattern is considered accurate for trading. It signifies a brief pause in the current trend, after which the trend is expected to continue in the same direction.
The rectangle pattern is a price pattern that moves back and forth within a specific range. It is characterized by horizontal lines that represent levels of support and resistance. These levels create a rectangular or box-like shape on the price chart, hence the name "Rectangle Pattern."
Rectangle patterns are like road signs for traders. They usually tell us that the current trend will keep going after taking a little break, but sometimes they can suggest that the trend might change its course.
How to Identify Rectangle Price Pattern
A rectangle pattern in trading has the following key characteristics:
- Horizontal Lines: It's defined by parallel resistance (upper) and support (lower) lines.
- Consolidation: Prices move sideways, showing market indecision.
- Breakout Potential: Traders watch for a price breakout from the pattern.
- Price Targets: The height of the pattern used to estimate potential price targets after a breakout.
Another crucial aspect to keep in mind when dealing with rectangle patterns is trading volume. In these patterns, the trading volume is usually lower than when prices are clearly trending up or down.
This happens because there's a balance between buyers and sellers, which makes prices move sideways. Paying attention to volume will help you avoid false breakouts, which we will explain later.
Types of Rectangle Patterns
There are two types of rectangle patterns, namely bullish rectangle and bearish rectangle.
As the name suggests, the bullish rectangle pattern is a rectangular pattern that signals an upward or bullish price movement. When this pattern breaks out of the resistance, it can be seen as a chance to buy in the market.
The bullish rectangle pattern can act as either a continuation or a reversal pattern.
In a continuation pattern, the price was previously going up, and then it takes a pause during the rectangle formation. Afterward, there's a legitimate breakthrough of resistance, hinting at a strong possibility for the price to keep rising.
Conversely, in a reversal pattern, the price used to be on a downward trend. Then, it forms a rectangle pattern and eventually breaks through the resistance level.
The bearish rectangle pattern is basically the opposite of the bullish one. It suggests the possibility of prices going down after breaking the support level. So, it's a chance to sell in the market.
Just like the bullish rectangle pattern, the bearish one can be either a continuation or a reversal pattern.
How to Trade Rectangle Pattern?
There are two ways to trade the rectangle pattern, which are the breakout and the pullback methods.
The breakout method is the most commonly used approach in trading rectangle patterns. In this approach, you jump into your trade right after a solid breakout from the rectangle pattern.
Here are the simple steps to put this method into action.
- Identify the Rectangle Pattern: Start by finding a price that's going through a consolidation phase. Look for at least two horizontal tops and two bottoms.
- Spot the Breakout: Watch for the price to break through the rectangle's support or resistance line.
- Enter the Trade: Once you see a breakout, enter a trade in the direction of that breakout.
- Protect Your Trade: Place a stop loss in the middle of the rectangle's range or below the recent low price. For the take-profit target, aim for at least the size of the rectangle pattern.
- Exit Strategy: Hold onto the trade until the price movement covers at least the pattern's size. If market conditions allow, you can aim for more profits with trailing stops.
The pullback method is another popular approach when trading rectangle patterns. In this method, you wait for a temporary pullback in the price after a breakout, aiming to enter the trade at a potentially more favorable price.
Here's how to apply this method step by step:
- Identify the Rectangle Pattern: Start by identifying a price chart showing a consolidation phase with two horizontal tops and two bottoms.
- Spot the Breakout: Keep an eye on the price movement to spot a clear breakout from the rectangle's support or resistance line.
- Wait for the Pullback: Instead of entering the trade immediately, wait for a pullback in the price. This means a temporary reversal against the breakout direction.
- Enter the Trade: After the pullback, when you believe the price is about to resume its breakout direction, enter the trade. This can ensure a more confirmed and reliable trade compared to entering right after the initial breakout.
- Protect Your Trade: As always, place a stop loss to manage risk. Position your stop loss in the middle of the rectangle's range or below the recent low price. For your take-profit target, set it at least as the size of the rectangle pattern.
- Exit Strategy: Keep the trade open until the price movement equals or exceeds the pattern's size. If market conditions remain favorable, you can think about pursuing extra profits.
Tips to Minimize False Breakouts
Price breakouts can be tricky. Sometimes, prices break out briefly and then bounce back to their old trading range. These are called false breakouts and can lead to losses if you rely solely on price movements.
To tell apart real breakouts from fake ones, you can use trading volume as an extra clue. When a price breakout occurs, pay attention to the trading volume that goes along with it. A genuine breakout often comes with a surge in trading volume, showing that many traders are convinced the new price direction is the real deal.
If there's a lot of trading volume supporting the breakout, it's a good sign that the price move is for real and likely to stick around. This shows that many traders are getting behind the breakout.
On the flip side, if a breakout happens with low or decreasing trading volume, be cautious. These breakouts are more likely to be false signals because there might not be enough conviction in the market to support the new trend.
To help you understand how to incorporate rectangle price patterns in your trades better, we will provide two examples on the following charts.
#1 EUR/USD - Sell Setup
In the EUR/USD H1 chart below, you can observe the presence of a rectangle pattern. The price was consolidating within the range of 0.9957 to 1.0023.
Later on, the price continued its descent until it broke through the 0.9957 support level.
A sell position was initiated at 0.9950 with a stop loss at 0.9991 (40.9 pips), while the take-profit target was set at 0.9890 (59.5 pips).
Following the entry of the sell position, the price continued its downward trajectory, eventually reaching the take-profit level at 0.9890. This resulted in a successful gain of 59.5 pips for the sell position.
#2 AUD/USD - Buy Setup
In the AUD/USD H1 chart below, you can spot a rectangle pattern forming. The price has been oscillating within the range of 0.6576 to 0.6628.
In the next stage, the price kept testing the resistance and eventually broke above it at 0.6628. Once this breakout was confirmed, it signaled a reversal into a bullish rectangle pattern.
From there, we simply waited for the price to dip and test the previously strong resistance, which had now turned into a support level. As the price successfully tested this support, we entered a buy position.
We entered the trade at 0.6636, with a stop loss at 0.6608 (28.5 pips). For our take-profit target, we used the same price range as the previous rectangle pattern, setting it at 0.6683 (46.3 pips).
Following our entry, the price continued to rise and eventually reached our take-profit level at 0.6683 (+46.3 pips).
The rectangle pattern is a price pattern that moves back and forth within a specific range. It's like drawing a box on the price chart because there are horizontal lines at the top and bottom, showing where the price tends to stop or bounce back.
The rectangle pattern isn't inherently bullish or bearish. It depends on the trend that comes before it. If it follows an uptrend, it can be seen as bullish, indicating a potential continuation. If it follows a downtrend, it may be seen as bearish, suggesting a potential downward continuation.
Traders can use two methods for clear risk and reward planning: breakout and pullback. Additionally, paying attention to trading volume helps identify real breakouts and reduces false signals.
Nevertheless, remember trading always involves risks, so have a solid risk management plan in place and test this pattern in a demo account before using it for real.