There are only a few chart patterns that are 'proven' predictors of tops or bottoms. Rectangle 'tops' are supposed to be one of them but sideways moves are sometimes tricky as to an eventual outcome.


"How did you figure the dow had maybe hit bottom or what was a calculation for it?"


I want to give a little background on rectangle patterns as it relates to one way to get some idea of a possible downside objective that may have been reached recently in the Dow.


What is it? A sideways trading range that forms after either an uptrend or downtrend that most often is consolidation of the prior trend before a further move in the same direction as this trend. The name comes from the shape of the pattern, which requires a sideways move that goes on long enough that the pattern's width is greater than the trading range is high. Sometimes a rectangle will end up forming what turns out to be a TOP or BOTTOM. So, a rectangle formation will suggest either a 'continuation' (of the existing trend) pattern OR a reversal pattern.

A rectangle pattern has typically two or more lows in the same area and two or more highs at equal or similar levels. If the sideways trading range/rectangle follows an uptrend, this suggests an eventual further advance or a move in the SAME direction as the prior trend. If the sideways trading range/rectangle follows a lengthily downtrend, this suggests an eventual new DOWN leg and a breakout to the downside. In about 3 out of 4 instances after a rectangle formation, the PRIOR trend resumes.

In other instances, about a quarter of the time, the rectangle pattern 'sets up' a trend REVERSAL. How to tell the difference between a rectangle suggesting a resumption of the dominant trend OR a reversal of the dominant trend? We assume (about 75% of the time) the PRIOR trend will resume but trade in the direction of the breakout price thrust if this isn't the case.

My first chart is of the Nasdaq 100 (NDX) Index. There was a move higher from the NDX 2009 low around 1050 into the period shown below, which was also about a year of a sideways move. Sound familiar! Except for a panic sell off/low as noted as the 'odd man out' dip, the trading range or 'rectangle' pattern was between the 2150 area and 2400. The rectangle formation highlighted here was a classic 'consolidation' of the prior trend ahead of another move in the direction of the dominant trend; i.e., UP.

There's also a rule of thumb measurement for a 'minimum' upside objective as equal to the top of the rectangle minus the low (support) end ADDED to the upper line in the case of an upside breakout. This objective was easily met. Assume the NDX trading range was 2100 to 2400, 300 points. Add 300 to 2400 equals 2700. As I said this is a suggested 'minimum' upside objective.

A rectangle pattern that ends up tracing out a bottom and which suggests a REVERSAL in the dominant trend is seen back at the years prior start of the current bull market and also using the Nas 100 as an historic example.

The trend was down, then sideways (a rectangle) which could have been a 'consolidation' of the prior bear market. However, after a decisive upside penetration of the upper end of the prior trading range, the trend powerfully reversed to bullish/up.

Note the NDX double top traced out in the sideways rectangle period shown and the more pronounced double bottom. What made the 'double bottom' more 'pronounced'? The answer is simply that more time passed BETWEEN the two lows. Both the double top and double bottom were significant from a trading perspective. But, the double bottom was the more 'powerful' signal so to speak; that and the upside breakout move that came later.

Now back to the question about projecting a downside target for the Dow 30 (INDU) based on the 'rule of thumb' in measuring how far a 'breakout' move below the low end of the INDU rectangle will carry, at least at a 'minimum'.

Note that the rectangle pattern traced out in INDU was also part of a distinct double top; i.e., prices rose into the first top, pulled back, a second top then formed in the same area, followed by prices falling away again. I discounted the double top in the Dow as this was a pattern not repeated distinctly in the S&P and certainly not in Nasdaq. Moreover, I thought the low end of the trading range/rectangle would hold in the same area as previously. WRONG! Double tops and double bottoms are strong predictors that a significant top, or bottom, has formed.

The TYPE of rectangle seen next as being a rectangle 'top' was ONLY determined upon the decisive downside penetration of the low end of the prior INDU trading range; i.e., at 17100-17070. You can't definitively determine that this rectangle was a reversal pattern, a rectangle top; except in hindsight AFTER the Dow pierced the low end of the box. After this event, a rule of thumb measurement of a 'minimum' downside target is highlighted on the chart.


Dr. Andrew Lo of MIT did extensive research on the 'randomness' (or not) of stock price fluctuations and his team found 5 chart patterns with 'predictive' results as to the further or future direction of the trend in stocks or stock indexes. Those 5 chart patterns they researched and reported on are:

1.) The Head & Shoulders, with H&S tops predominating.

2.) Double tops. (I find double bottoms telling also!)

3.) Rectangle tops.

4.) Rectangle bottoms.

5.) A 'broadening' bottom.