The Rectangle Bottom Pattern
A Rectangle Bottom pattern is a chart formation which takes place over the course of several candlesticks on a daily chart. It is considered a bullish reversal pattern.
Rectangle Bottoms form when price enters a channel; a tight price range between which a stock trades back and forth. Whilst traditional channels tend to be slanted upward or downward, a Rectangle Bottom is essentially a channel which trades horizontally after leading out of a downtrend. In fact, some analysts refer to the Rectangle Bottom strictly as a horizontal channel. Regardless of what it is called, Rectangle Bottoms are rare in the world of chart patterns.
The psychology behind Rectangle Bottoms is one of consolidation. Both bulls and bears are unsure of how much they want to invest in a rally. As a result, price trends within a narrow corridor that eventually breaks out in one or the otherâ€™s favour. Because the Rectangle formation appears as a â€œbottom,â€ it is often expected by traders to break into an upward trend. Indeed, they do break upward, but less often than they break downward.
According to technical analyst Thomas Bulkowski, however, Rectangle Bottoms break downward in 55 percent of all cases. In this way, the pattern can be considered a bearish continuation. The statistics on Rectangle Bottoms reflect the near-randomness that should leave traders seeking complementary market elements to better inform their positions. This can take the form of seeking out candlestick patterns within the Rectangle, analysing trend maturity, or reviewing the stockâ€™s performance with support-resistance levels.
Candlestick patterns must be taken with a grain of salt as the less reliable ones can be overridden by the context provided by the Rectangle Bottom. Thus, if a Bullish Harami pattern forms in the midst of a developing Rectangle, for example, cautious traders should set their buys above the upper trend line of the horizontal channel. What they should not do is get their hopes up, however, as the Rectangle Bottom stands a near 50-50 chance of breaking into a bull market. Nevertheless, candlestick patterns may help from time to time in clearing away some of the confusion and uncertainty inherent in a consolidation pattern such as this.
Otherwise, trend maturity will typically play a big role in determining a Rectangle Bottomâ€™s breakout potential. If the trend is mature, the Rectangle will have a better chance of breaking upward as the market fatigues on selling pressure. Likewise, a short downtrend can lend to a bearish continuation or a downward breakout after the Rectangle, as the bears are merely using the time to regroup before pushing prices even lower. Then again, even an extended downtrend leading into a Rectangle Bottom can result in a downward breakout if the bears take enough time to rally one final time. As always, traders will have to use their best judgment.
Breakout direction can generally be positioned for with a measure of accuracy for those Rectangle Bottoms that form near support-resistance levels. Depending on the prevailing trend leading into the Rectangle, this may have more to do with the support-resistance than the pattern itself, but it proves a reliable indicator of breakout all the same when coupled together. Thus, traders who spot a Rectangle Bottom near a level of support can wager that the stock stands a very good chance of breaking upward. If the market has repeatedly tested the level in question leading up to the Rectangleâ€™s formation, however, then the market may be taking a breather before getting ready to break the support and establish a new level. Context will be key to streamlining all the variables.
Rectangle Bottoms confirm as a bearish continuation when price closes below the bottom trend line of the pattern. As a bullish reversal, it confirms when price closes above the upper trend line of the pattern.
The characteristics of a Rectangle Bottom are summarised below:
- Price trades within a horizontal channel.
- Considered to be a bullish reversal but actually behaves as a bearish continuation over half of the time.
- It represents a period of consolidation.
- The market leading to the pattern will be in a downtrend.
- Confirmation as a bearish continuation occurs when price closes below the bottom trend line.
- Confirmation as a bullish reversal occurs when price closes above the upper trend line.
- Candlestick patterns, trend maturity and support-resistance levels can influence breakout direction.
In the example below, the stock Incitec Pivot (IPL.AX) established a Rectangle Bottom during May, June, and early July of 2011. The stock traded back and forth across the level of resistance at 3.757 within a narrow corridor before breaking upward. However, the upward breakout immediately forms a Bearish Separating Lines Candlestick pattern, itself a signal of bearish continuation. No discernible candlestick pattern is present at the close of the Rectangle Bottom to guide traders in clarifying breakout potential, so the Bearish Separating Lines is the closest to a candlestick pattern available at the moment.
The market responds by dipping in price briefly before climbing upward again. This rally is short-lived before IPL begins gapping downward and testing resistance at 3.595 and 3.757 repeatedly. Eventually, the stock plummets even further, proving the Rectangle Bottom a more-or-less reliable guide to the resultant bear market despite the brief upswing after the Separating Lines formation.
Popularity: 44% [?]