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Continuation Chart Patterns

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Rectangle Continuation

Rectangle is a rally to a relative new high, pullback to an intermediate support level, a second rally to test the new high, a second pullback to intermediate support, a third rally to test the new high level followed by an upside breakout on strong volume.

The technical target for a rectangle is derived by adding the point difference between top#1 and the reaction low to the new breakout level.

Rectangle Continuation

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Rectangles are sometimes referred to as trading ranges, consolidation zones or congestion areas.

  • Trend: To qualify as a continuation pattern, a prior trend should exist. Ideally, the trend should be a few months old and not too mature. The more mature the trend, the less chance that the pattern marks a continuation.
  • Four (4) Points: At least two equivalent reaction highs are required to form the upper resistance line and two equivalent reaction lows to form the lower support line. They do not have to be exactly equal, but should be within a reasonable proximity. Although not a prerequisite, it is preferable that the highs and lows alternate.
  • Volume: As opposed to the symmetrical triangle, rectangles do not exhibit standard volume patterns. Sometimes volume will decline as the pattern develops. Other times volume will gyrate as the prices bounce between support and resistance. Rarely will volume increase as the pattern matures. If volume declines, it is best to look for an expansion on the breakout for confirmation. If volume gyrates, it is best to assess which movements (advances to resistance or declines to support) are receiving the most volume. This type of volume assessment could offer an indication on the direction of the future breakout.
  • Duration: Rectangles can extend for a few weeks or many months. If the pattern is less than 3 weeks, it is usually considered a flag, also a continuation pattern. Ideally, rectangles will develop over a 3-month period. Generally, the longer the pattern, the more significant the breakout. A 3-month pattern might be expected to fulfill its breakout projection. However, a 6-month pattern might be expected to exceed its breakout target.
  • Breakout Direction: The direction of the next significant move can only be determined after the breakout has occurred. As with the symmetrical triangle, rectangles are neutral patterns that are dependent on the direction of the future breakout. Volume patterns can sometimes offer clues, but there is no confirmation until an actual break above resistance or break below support.
  • Breakout Confirmation: For a breakout to be considered valid, it should be on a closing basis. Some traders apply a filter to price (3%), time (3 days) or volume (expansion) for confirmation.
  • Return to Breakout: A basic tenet of technical analysis is that broken support turns into potential resistance and visa versa. After a break above resistance (below support), there is sometimes a return to test this newfound support level (resistance level). (For more detail, see this article on support and resistance.) A return to or near the original breakout level can offer a second chance to participate.
  • Target: The estimated move is found by measuring the height of the rectangle and applying it to the breakout.

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