Rectangle Complete Guide

What is Rectangle?

The Rectangle chart pattern, often referred to as a 'trading range' or 'congestion area,' represents a period of consolidation where the price moves sideways between two parallel horizontal lines. These lines act as clear support and resistance levels. According to Thomas Bulkowski’s Encyclopedia of Chart Patterns, the rectangle is technically a neutral pattern until a breakout occurs, though it most frequently acts as a continuation of the prior trend. It forms when there is a temporary equilibrium between buyers and sellers, often after a sharp price movement. Visually, the price must touch each horizontal boundary at least twice, though three touches are preferred for higher reliability. Volume typically trends downward as the pattern matures, reflecting a decrease in conviction among traders within the range. A decisive breakout, accompanied by a surge in volume, signals the pattern's completion. Bulkowski’s research indicates that rectangles are highly reliable. For example, bullish rectangles in a bull market have a failure rate of approximately 9% once the price closes outside the formation. The average price rise following an upward breakout is roughly 35%. However, traders should be wary of 'throwbacks' or 'pullbacks,' which occur in about 65% of cases, where the price returns to the breakout level before continuing its trend. Steve Nison also notes that in candlestick charting, these ranges represent a 'battle' where neither the bulls nor bears have gained control, making the eventual breakout a significant momentum signal.

Identification Rules

1. The price must fluctuate between two horizontal, parallel trendlines acting as support and resistance.
2. There must be at least two distinct touches of the upper resistance line and two distinct touches of the lower support line.
3. The pattern must consist of at least 20 price bars to establish a valid consolidation range.
4. Volume should generally decline during the formation and significantly increase upon a breakout close.

References

• Thomas N. Bulkowski (2005). Encyclopedia of Chart Patterns.
• Steve Nison (2001). Japanese Candlestick Charting Techniques.

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