The Rectangle Formation

The rectangle formation often goes by other names, but is usually easy to spot on a price chart. It represents a pause in the trend during which prices move sideways between two parallel horizontal lines.

The rectangle is sometimes referred to as a trading range or a congestion area. In Dow Theory parlance, it is referred to as a line. Whatever it is called, it usually represents just a consolidation period in the existing trend, and is usually resolved in the direction of the market trend that preceded its occurrence. In terms of forecasting value, it can be viewed as being similar to the symmetrical triangle but with flat instead of converging trend lines.

A decisive close outside either the upper or lower boundary signals completion of the rectangle and points the direction of the trend. The market analyst must always be on the alert, however, that the rectangular consolidation does not turn into a reversal pattern. In the uptrend shown that the three peaks might initially be viewed as a possible triple top reversal pattern.

The Importance of the Volume Pattern

One important clue to watch for is the volume pattern. Because the price swings in both directions are fairly broad, the analyst should keep a close eye on which moves have the heavier volume. If the rallies are on heavier and the setbacks on lighter volume, then the formation is probably a continuation in the uptrend. If the heavier volume is on the downside, then it can be considered a warning of a possible trend reversal in the works.