“Rectangle Channels” are continuation patterns. Rectangle channel breakouts in the trend direction are more reliable than breakdowns against the trend. Rectangle channels form more in the beginning stages of longer-term trends. A base building before a clear trend run is a very reliable pattern.
“Rectangle” channel tops are rarely formed compared to the channel “bottoms.” Intermediate trend “rectangle” formations are reliable continuation patterns and they continue in the prior trend directions.
A trade in “Rectangle channels” is triggered when a top (resistance) or bottom trend line (support) is broken and confirmed by price-action. A “long” trade is entered when price closes above the high of the breakout bar. A “short” trade is entered when price closes below the low of the breakdown bar.
Target: The width of the “Rectangle” channel usually defines the resulting target move. The wider the rectangle (like base), the bigger the move. The height of the rectangle, at the top to bottom trend line, is the first target in “Rectangle” channel trades.
Stop: “Rectangle” channel failures can happen if prices trade against the prior trend before the pattern formation. A “stop” order is placed at the middle of the rectangle channel to protect the trade.
Trading Rectangle Channels
Trading Rectangle Channels
The example above shows A “Rectangle” channel formation from the Dow Emini futures (YM) 30 minute chart. The first “Rectangle channel” pattern was confirmed in early October as it closed below the lower trendline. But there was no trade triggered as prices never traded below the breakdown bar’s low. On October 3, YM traded higher and closed above the upper trend line to confirm a “Rectangle” channel breakout in prior trend. A “long” trade is entered in the direction of the prior trend before the “Rectangle” formation (up side). A “stop” order was placed at the center of the channel. A target is set at the height of the “Rectangle” channel from the breakout level. The following week, a second “Rectangle” channel emerged with a similar long trade setup.
Trading Rectangle Channel
The example above shows a “Rectangle” channel formation from the Level Three Communications (LVLT) daily chart. From February 2006 to April 2006, LVLT traded in a narrow range “Rectangle” channel from $3.25 to $3.75. In late March 2006, LVLT traded outside the “Rectangle” channel suggesting a potential upside in the stock. Most “Rectangle” channels are continuation patterns and trades are entered in the prior direction of the trend before the channel formation.
- Enter a “long” trade above the high of the breakout bar.
- Place a “stop” order below the low of the “rectangle” channel.
- Targets are set at rectangle’s height from the breakout level.