There are bottom and top patterns that take lengthily periods to form as in trends that start going sideways. Often, in that sideways move, prices will hit the same approximate highs and lows 2-3 or more times. A horizontal line can then be drawn through the tops or bottoms that are the stopping points for 2-3 or more upswings and 2-3 or more downswings. This pattern then forms a so-called 'rectangle'.
RECTANGLE TOPS AND BOTTOMS:
A trader friend the other day asked me to give my opinion on anything of interest (technically) in Apple's (AAPL) chart. I said the most obvious was a possible rectangle top. I said 'possible' as the pattern highlighted in my first chart here has not yet pieced EITHER the high or low end of the rectangular square I've drawn on Apple's daily chart. There is a 'measuring' implication of the rectangle pattern, which you see on my chart.
A decisive upside penetration of EITHER the upper or lower end of the square outlined above suggests a next advance or decline at least equal to the distance between the line of the prior highs and lows. I've only noted above the downside potential. The upside potential on a breakout ABOVE the line is the same 34, but added to 360 to equal a possible next price objective of 394. I happen to think AAPL looks more like it's building a TOP, but my hunch is not proven until there's a decisive DOWNSIDE penetration of 326 in AAPL.
A sideways move after a strong advance or decline is most often a continuation type pattern; i.e., prices are marking time or 'consolidating' BEFORE continuing in the same trend direction. In a minority of instances the pattern does NOT wind up part and parcel of a consolidation. That 'not' is the minority of times when the rectangle pattern turns out to mark a top or bottom. However, not to worry fellow traders, in either case go with the direction of the breakout.
A rectangle is something Charles Dow called a line formation. A 'rectangle' has to be imagined, or actually drawn, by two horizontal lines connecting a series of similar highs and similar lows, creating a sideways trading range formation that 'interrupts' an advancing or declining trend. The rectangle most often proves to be a sideways consolidation prior to the resumption of the dominant trend. In some instances the rectangle suggests formation of a top or bottom and becomes the prelude to a trend reversal.
There's a rectangle top pattern that formed in Intel (INTC) over November to early-March. We chalk it up as a top/reversal pattern after INTC fell sharply under 20.5 on a bearish downside chart gap. The subsequent return to the 20.5 area was the opportune time to short the stock. The implied 'minimum' downside objective to 19 hasn't been seen yet, but the chart looks bearish, with 19 as a next measured move objective. Stay tuned on this outcome!
The GE chart over the 2001-2002 period provides a clear cut example of a rectangle top. This pattern can also be seen as a triple top in terms of the main clusters of the rally peaks.
The key to a rectangle is to trade in the direction of the strong price swing that often results after an upside or downside penetration of the top or bottom of the rectangle.
I mentioned already studies done by Dr. Andrew Lo at MIT as to whether technical price 'patterns' had future predictive value. Among the 5 he found that did, so-called rectangle tops and rectangle bottoms were 2 (of 5) chart patterns they found significantly correlated to the expected outcome. If a rectangle forms after an advance, but the breakout is downward and the following price trend continues lower, it is considered to be a rectangle top. Conversely, if a rectangle formed after a decline and the direction of the breakout is UP, this becomes a rectangle bottom and a reversal pattern.
A chart from my book shows a rectangle top preceded by an uptrend. As with trendlines, it can be appropriate to take out one (or more) spike highs or low in terms of best 'defining' a rectangle; the key is to use the MOST number of points which was 3 in this next example of the major top formed by Apple (AAPL) Computer back when. Don't you wish you could buy at prices from those years and sell on today's market!
As always with technical chart patterns, the ones that have measuring implications for a potential next price objective (e.g., the Head & Shoulder's, 'flag' patterns, etc.) are very useful to traders. If you have some idea of a price target then you have a trade objective. If you have a trade objective, then it helps set a risk or stop-out (exit) point if the trade goes sour. Gain potential realized of 2-3 times (or more) the amount risked via a stop/exit point would keep you in a winning year even if every other trade was a loser.
MEASURING IMPLICATIONS â€“ RECTANGLE TOPS and BOTTOMS
After a breakout to the downside from a rectangle top, the minimum objective for a next price target is the price distance between the highs and lows SUBTRACTED from the lower line. After a breakout to the upside from a rectangle bottom, the minimum objective for a next price target is the price distance between the highs and lows ADDED to the upper line. Any 'minimum' upside or downside objective is only that. Minimums of course might NOT be realized or quite realized. Often minimum price objectives will be exceeded, sometimes dramatically so. Also, in general the longer the sideways trend, the bigger will be the resulting breakout move above or below the top/bottom of the rectangle.
A rectangle, preceded by a downtrend, is highlighted in my last chart, that of what used to be Philip Morris (MO) when it was in the Dow. The rectangle turned out to be a reversal pattern and the next move (up) in MO exceeded a 'minimum' upside objective to $36 as MO ended up around 50. There were 2-3 or more lows in the same approximate area and 2-3 or more highs in the same approximate area so that both lows and highs formed 'lines' defining the upper and lower end of an imagined rectangle:
As it always true for any minimum price objective rule of thumb, such rules are useful for an initial objective at the time of the breakout. After the trend develops, you need to follow the trend developments and also use other technical analysis analytical tools (e.g., trendlines), in order to see just how the price trend may extend in terms of duration and price.
GOOD TRADING SUCCESS!