What are Rectangles and Price Channels?
A rectangle pattern is a price range where the price is confined between two roughly horizontal lines. When the range has an upward or downward slope, the market is trending and the range is then known as a channel.
In both a channel and a range, the upper line forms a resistance area and the lower line a support area. The price doesn’t have to be perfectly aligned with the top or the bottom line for it to be a true range. Actually we seldom see real cases where this happens.
When looking for these patterns, the main thing is to confirm that the price is “bound” within a defined support and resistance area. Both rectangles and price channels and are then useful chart patterns.
For help with identifying these patterns, you can use our Metatrader indicator.
What’s the Meaning of Channels and Rectangles?
Although they have similar appearance, the market dynamics in both of these patterns is different.
Rectangles are consolidations areas. This means that the market is in a directionless state with neither bearish nor bullish sentiment prevailing. Rectangular patterns are usually shorter in duration than channels.
Price channels form when the market is trending. Channels can extend for long periods of time; weeks, months even years. Therefore they can create great opportunities for trend following strategies.
Reversal or Continuation?
Small rectangular ranges can show as short consolidation phases within a trend. This happens when trending takes a brief pause. These patterns are then very similar to flags and pennants and are traded as continuation signals.
Upward sloping channels are traded as bullish continuation patterns, whereas downward sloping channels are bearish. However when they first appear it’s very easy to confuse them with flags and pennants. They look identical.
When trading a price channel in its direction of travel, you need to make sure it has clearly formed into its own trend.
Trading a Rectangle Range as Trend Continuation
For a continuation pattern, we need to look for some signals to confirm the fact before entering the market.
In this example, USDCHF hourly is in a trend down. The patterns and lines are generated by our Metatrader pennant/flag indicator. This tool also detects price channels and rectangles.
There are two noticeable patterns.
The first is a wedge. It looks like some buyers took this as a sign of a new uptrend. A breakout does form, but it fails to follow through. The down trend resumes.
The rectangle then starts to form as the trend consolidates sideways without clear direction. This rectangle range has a strong support at the base. But it’s also held down by a strong upper resistance line.
The price pierces the upper resistance line but fails to hold out above that level. The bears are then dominant and the price drops below the lower horizontal support line.
Afterwards the support line is retested. See the shaded circle in the chart. This is a good point to sell as some further downside now seems imminent.
Using a Price Channel to Trade a Trend
Channels provide good entry and exit points for trend trading. Once established strong price trends are often be long-lasting, and can provide a good amount of upside potential.
Figure 3 shows an example of a channel pattern on USDJPY H4. The channel forms a strong upward trend lasting several months.
In this case the boundary lines of the channel create good opportunities either for selling at the top or buying at the base.
This is just a system of selling at resistance and buying at the support. The only difference here is the market is trending up. So higher weight and a wider profit target can be given to the long side.