Amazing Rectangle Chart Pattern Strategy
In today’s trading strategy tutorial, you’ll learn how the pros trade the Rectangle chart pattern strategy. We also call this the rectangle trading strategy because it is one of the simplest technical price actions that you can trade. You'll learn everything you need to know about rectangle patterns, the psychology behind the rectangle pattern, buy and sell rules and more. Before trading with real money always you do your own due diligence.
Our team at Trading Strategy Guides is launching a new series of articles called Chart Pattern Trading Strategies - A Step-by-Step Guide, which will enhance and elevate your trading to a new level. These chart pattern strategies will give you a framework to methodically examine the fight between the bulls and the bears. This series has also been called the chart patterns cheat sheet.
By trading the most profitable chart patterns you’ll be able to determine who is winning the fight between the bulls and the bears.
This a classical price action trading strategy that contains the price action between two horizontal lines that show significant support and resistance levels. The beauty of this pattern is that it develops with the same frequency on all time frames. This means no matter your trading style, you can use these trade principles in your own strategy. Also, read more about Price Action Trading.
Throughout this article, we’re going to explain the requirements of a good setup and how to spot them. Furthermore, we’re also going to explain the psychology behind this accurate strategy we are going to teach you today.
We’re also going to provide you with a very clear step-by-step set of rules so you can trade the rectangle chart pattern forex by yourself. Also, read How Currency Pairs Work in Forex.
Moving forward, we’re going to discuss what makes a great setup and highlight five basic trading rules to conquer the markets with the Rectangle chart pattern strategy.
What is Rectangle Trading Pattern?
The rectangle strategy it’s both a continuation trade signal as well as a reversal trade signal. However, they are more powerful if used as a continuation pattern because you have the force of the trend working for you. One thing to remember is that this is one of the best ways to begin trading forex with a breakout strategy.
Keep in mind that this trading system doesn’t have a bullish or a bearish bias as they are neutral patterns when they develop. You’re not going to know which way it’s going to break until it does but, the high probability trade will always be in the direction of the prevailing trend.
How to Draw a Bearish Rectangle Pattern
There are two requirements that need to be satisfied to be able to draw the bearish rectangle formation:
- First, we need an established trend because the big money is made when it’s used as a continuation pattern.
- Secondly, we need to have at least two equal (or near the same) lows and highs to draw two horizontal lines at should contain the price action.
This has a lot of striking similarities with the flag Pattern but the difference is that the price action moves flat and horizontally.
The Psychology behind Rectangle Trading Pattern
The battle between the bulls and the bears is highlighted by the double bottom reversal pattern very well.
Inside the rectangle trading pattern, there is a consolidation that shows that no one is really in control of this market. Neither the bulls or bears.
Our team at TSG likes the rectangle breakout strategy because we understand why it works. In other words, this method uses psychology in trading because you can see when other traders are in emotional and financial pain.
The main mistake retail traders make is to trade the consolidation price and place their protective stop loss above/below. As more stops build-up above/below the chart, the more important these levels become for the institutional traders who need the liquidity provided by these orders to execute their big trades.
Now, let’s see how you can effectively trade with the pattern and how to make profits from basically using naked forex charts.
Rectangle Chart Pattern Strategy – Sell Rules
Now that you’re familiar with the rectangle price formation, let’s walk through an easy step-by-step guide that will allow you to skim the markets. This next section details the sell rules for the rectangle chart pattern trading strategy.
The wonderful thing about this particular method is that there’s a very easy way of knowing how high or how low it will send the currency price.
We’re going to present you with an unorthodox approach of trading the rectangle breakout. This is a never seen before trading technique that you can use your disposal.
Let's begin and dive into the forex rectangle chart pattern step-by-step guide:
Step #1: Identify the prevailing trend before the rectangle trading pattern. For Sell Orders, we need a downtrend.
Just because you can spot this during rectangle pattern technical analysis, it doesn’t mean you have to jump straight into the market and trade it. Remember, we need the right context and everything needs to line up for a tradable rectangle breakout.
So, the first step is to identify the market trend prior to the rectangle price formation.
As we previously established for sell orders we need to have a prior downtrend in place to begin to develop a bias for a short position.
Establishing the phase of the market aka identifying the trend is probably the biggest ingredient that can determine the success rate of the rectangle breakout.
Step #2: Identify the rectangle trading pattern. The price action needs to move horizontally between support and resistance.
The second step is to identify the rectangle price formation by applying the previously mentioned rules.
Basically, all you need to do is to spot one support and one resistance level that must contain the price action. Here you can read the simple yet profitable strategy.
Our article Support and Resistance Zones – Road to Successful Trading will teach you all you need to know to be able to identify support and resistance levels.
The secret sauce of this method is created by what we call the rectangle false breakout and which is the next step to successfully trade the rectangle pattern forex.
Step #3: Wait for a false breakout above the rectangle resistance line.
We use a special trade technique that allows us to only trade high probability rectangles.
Normally, for a sell order, we want to see a break below support to get an entry confirmation. However, before we get to this point we also want to see a false breakout above the rectangle resistance line.
But, why is the false breakout important to the Rectangle chart pattern strategy?
The false breakout does two things:
- First, it stops out traders who went short in the direction of the prevailing trend and placed their stop above the most recent resistance level.
- Secondly, it traps some buyers who take the resistance breakout trade.
Both of these two actions will fuel the downside momentum when the rectangle breakout happens.
So far, so good.
Now, we need to determine an entry technique so that we can ensure we have the highest accuracy level that we possibly can.
Step #4: Sell at the closing candle that generates the Rectangle Breakout.
After we identify the market trend and the characteristics of a good rectangle pattern design we need to wait for confirmation that the trend is about to resume.
The rectangle breakout candle is our signal that the trend is about to resume and it’s what it confirms and validates our entry position.
Rather than guess the direction, just wait and let the price activity tell you in which direction we’re going to go. When trading with the Rectangle chart pattern strategy you’re looking for the opportunity when you get a breakout below the rectangle bottom to be a seller.
When the rectangle breakout happens that is a confirmation that the bears have taken control of this market.
Note* - We recommend waiting for the breakout candle to close below the rectangle chart pattern. You may also enjoy reading about the double top pattern system.
Step #5: Take Profit target can be 2-3x the rectangle price range as measured from top resistance to bottom support.
With this particular pattern, you can get a target for how high you can expect the price to go from the rectangle breakout.
According to the textbook, you can measure the distance between the two parallel lines and add that to the breakout in order to obtain your profit target.
The next important thing we need to establish is where to place your protective stop loss.
Step #6: Place the protective stop-loss slightly above the Rectangle Resistance level.
The system gives you a simple way to quantify risk because you can place your protective stop-loss slightly above the rectangle pattern. Here is a strategy you can read about and its called risk to reward ratio.
The rectangle trading platform really gives you the opportunity to also trade with a tight stop loss, which is great as we always want to keep losses at a minimum.
Note*** The above was an example of a SELL trade… Use the same rules – but in reverse – for a BUY trade. In the figure below, you can see an actual BUY trade example, using the bullish rectangle pattern.
Conclusion - Rectangle Pattern Trading Strategy
The main reason why the rectangle top chart pattern is widely used and is so popular is that it’s easy to identify on a price chart. It's also a real-time tool whereas an indicator is lagging. This makes the rectangle pattern powerful in comparison with indicator trading.
This pattern is a little bit underrated but we have done pretty well over the years trading the rectangle breakout.
Please also don’t forget to check out our previous strategy tutorial on Double Bottoms.
Thank you for reading!
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