Understanding Rectangles on Forex
Here’s is where we start to have some fun. Regardless of how you want to trade the markets you need an approach. It might be spinning a bottle, asking your Aunt Jenny what she thinks or just gut feel. However you do it, even though you may not think so, you have an approach.
The majority of traders will eventually use some form of technical analysis (also known as chart traders, market technicians and chartists). For every book that there is on making money trading there is probably an opposite book explaining why it can’t be done. Before you dismiss the last statement out of hand. Lets explore the argument that no matter what you do you can’t beat the market.
Rectangles can occur in any time frame and any market you are following. As with many chart patterns the pattern is in the eye of the beholder. I have found that some traders are better than others at identifying chart patterns. It may take some time before you can spot the most common patterns.
The rectangle contains price movement between two points in a rectangular shape to which we add lines to signify the upper boundary and lower boundary. These lines should be horizontal. Slanted rectangle will most probably fall into the realm of “Flags”, which we will discus in another lesson.
The top line should connect at least two bars and the bottom line should connect at least two bars. As most markets are in congestion most of the time rectangles are fairly common.
It is not necessary to draw the top and lower lines at the extreme of the congestion points but rather make sure the lines contain at least 95% of the congestion area. The longer the rectangle continues the more important the breakout.
To help identify a valid breakout there should be an increase in volume on the day (or time period) of the breakout. The breakout can occur in either direction but if you are in a defined up trend then an upside breakout is favored and vise versa for a down trend. If I am in a defined trend then I tend to view this pattern as a continuation patter unless it starts to break the other way.
There are a number of ways to trade the rectangle. You can buy or sell the breakout as it happens or you can wait to see if there is a pullback to the neckline. Once you have defined the rectangle you can also buy and sell at the boundaries of the rectangle. I prefer to buy at the lower boundary if in an up trend and sell at the upper boundary if in a down trend. This can be a very effective trade as the risk is small. If you sell at the upper boundary then your stop loss can be close to the boundary and vise versa for the long trade at the lower boundary.
If you sell the breakout place your protective stop inside the rectangle and do the same for buying the upside breakout. You can also measure the distance between the upper and lower boundaries and project the distance forward to get an indication of the size of the next move. If the distance from the upper to the lower boundary were 20 ticks then I would expect the next move to be at least 20 ticks.
Martin Chandra (forex-trading-tutorial.com) is a full-time investor. He has been researching investment strategies and make his own living. Learn more at forex-trading-tutorial.com
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