Pro traders know when this classic pattern shows up, it’s time to range trade

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A bull trend occurs when demand exceeds supply and a bear trend occurs when sellers overwhelm buyers. When bulls and bears hold their own without giving way, a trading range is created.

This sometimes leads to the formation of a rectangular pattern, which can also be referred to as a consolidation zone or a congestion zone. Bearish and bullish rectangles are generally viewed as continuation patterns, but in many cases they act as a reversal pattern signaling the completion of a major high or low.

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Before we learn more about the bullish and bearish rectangle patterns, let’s first discuss how to identify them.

Basics of the rectangle pattern

A rectangle is created when an asset makes at least two comparable highs and two lows that are almost at the same level. The two parallel lines can be used to connect the high and low points and form the resistance and support lines of the rectangle.

The duration of the rectangle can range from a few weeks to several months, and if that time is less than three weeks, it is considered a flag. Typically, the longer an asset spends in consolidation, the greater the potential breakout or collapse.

Bullish rectangle pattern

Bullish rectangle pattern. Source: TradingView

As shown above, the asset is in an uptrend but after the rally some bulls took profits and this resulted in an initial reaction high. After the price corrects, several dip buyers step in and stop the decline that forms the first low.

When demand outstrips supply, the asset tries to continue its upward movement, but when price approaches the previous reaction high, traders see profits again. The connection of these two high points with a straight line forms the resistance of the rectangle. When the price goes down, buyers are defending the previous reaction lows and this forms the support.

It is difficult to predict the direction of the breakout in advance and the price could trade for a few weeks or even months between support and resistance. For this reason, it is better to wait for the price to leave the rectangle before turning bullish or bearish.

In the example above, price breaks out of range resistance as demand exceeds supply. This could lead to a resumption of the uptrend.

Bearish rectangle pattern

Bearish rectangle pattern. Source: TradingView

As shown in the example above, the asset is in a downtrend, but when the price hits levels that traders consider to be undervalued, dip buyers absorb the supply and create a reaction low. The bulls then attempt to reverse direction, but sentiment is still negative and traders sell on rallies which is the reaction high.

Traders will buy the dip again when the price hits the initial reaction low but the bears block the rebound near the earlier reaction high. After that, the price gets stuck between the parallel lines and forms a rectangle.

The bearish rectangle pattern will complete when price breaks below the range support and closes. This usually leads to the resumption of the downtrend.

A bullish continuation rectangle pattern

THETA / USDT daily chart. Source: TradingView

THETA was in an uptrend before hitting resistance near $ 0.80 on September 30, 2020. On the flip side, buyers stepped in and stopped the correction near $ 0.55. Thereafter, the price remained stuck between these two levels until December 15, 2020.

The THETA / USDT pair broke the rectangle on December 16, 2020, indicating that the bulls had overwhelmed the bears. This signaled the resumption of the uptrend.

THETA / USDT daily chart. Source: TradingView

To achieve the goal of breaking out of the rectangle pattern, calculate the height of the rectangle. In the above case, the amount is $ 0.25. Add that value to the breakout level, which in the example above is $ 0.80. That gives the target target at $ 1.05.

After a long period of consolidation, if the uptrend resumes, it can outperform the target many times over, as described above. Traders can use the target as a reference point, but the decision to close or hold the trade should be made after considering the strength of the trend and signals from other indicators.

The same processes apply to bearish rectangles as shown below.

LTC / USDT daily chart. Source: TradingView

Litecoin (LTC) was in a strong downtrend, falling from $ 184.98 on May 6, 2018 to $ 73.22 on June 24, 2018. Buyers stepped in at this level and tried to bottom out, but the Bears weren’t in the mood to give in. They stopped the rebound on July 3, 2018 at $ 90. Thereafter, the LTC / USDT pair stayed between those two levels through August 6, 2018.

The bears reasserted their supremacy and pulled the price below the rectangle on August 7, 2018. The downward trend thus continued.

LTC / USDT daily chart. Source: TradingView

The target target after breaking through a bearish rectangle is calculated by subtracting the height of the rectangle from the breakout point. In the above case, the height of the rectangle is $ 17. Subtracting that from the breakdown at $ 73 gives a target target of $ 56.

The rectangle as a reversal pattern

ETH / USDT daily chart. Source: TradingView

Ether (ETH) peaked at $ 1,440 in January 2018 and started a sharp downtrend that hit $ 81.79 in December 2018. This level attracted strong buying from the bulls and the ETH / USDT pair rallied significantly. However, in June 2019, the bears stopped the rebound near the $ 300 mark. Thereafter, the pair remained stuck between these two levels until July 24, 2020.

The bulls pushed the price above the rectangle on July 25, 2020, indicating the beginning of a new uptrend. The bears tried to push the price back below the $ 300 breakout level but failed. This showed that sentiment had turned positive and traders were buying the slumps. The pair continued their upward trend in November 2020.

Although the pattern target for the breakout from the rectangle was only $ 518.21, the pair rose to an all-time high of $ 4,372.72 in May.

The central theses

The rectangle pattern is a useful tool because it can act as both a continuation pattern and an inverted pattern. When the rectangle is large, traders can buy near the support and sell near the resistance.

To take advantage of the rectangle and avoid faltering the trader, traders can wait for the price to break above or below the pattern and hold before building positions.

The target target should only be used as a guide, as when price breaks out of a long rectangle it tends to exceed the target target by a huge range.

The views and opinions expressed are those of the author only and do not necessarily reflect the views of Cointelegraph.com. Every step of investing and trading involves risk, so you should do your own research when making a decision.