THE RECTANGLE FORMATION

Today I want to discuss with you the "classical" technical analysis price pattern known as a rectangle. 

Price pattern analysis goes back to the work of Schabaker and Edwards and Magee. I call it "classical" technical analysis. It derived from a time when charts were hand kept on graph paper and even simple moving averages were not employed. There were certainly no indicators such as MACD at that time. The assumption of classical technical analysis was that price patterns repeat themselves over and over again throughout time. Pattern recognition means pattern prediction, and thus trading profit.

A rectangle describes a price pattern where supply and demand are in approximate balance for an extended period of time. The shares move in a narrow range, hitting resistance at the rectangle's top and finding support at its bottom. It is a pattern of indecision, one in which the bulls and bears are approximately equally powerful. Ultimately, one side or the other wins the tug of war and the shares break out or break down. Typically, the breakout or breakdown can be measured by the height of the rectangle.

A break below or above a support or resistance level would create a high-probability entry point for a swing trade. This is because of the "alternation principle." (I describe this in great detail in my trading course, which I have made available FREE to all StreetAuthority Swing Trader subscribers.) The alternation principle states that old support, when broken, becomes new resistance. The reverse is also true -- when old resistance is broken, it should then become new support.

Rectangles should usually not be traded until the pattern is resolved one way or another. While typically not yielding the swing trader enormous profits, on a breakout or breakdown they offer a low-risk entry point, a very clear stop and an explicit price target. It would be kind of "square" to ignore them.

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