Stocks & Commodities V. 25:6 (16-26): How Effective Are Rectangles? by Markos Katsanos
It’s one of the oldest patterns in technical analysis, but how reliable is it? By statistically evaluating the performance of rectangle formations, we can derive a new formula that can remove the guesswork from estimating the price target.
After having traded rectangle formations for some time, I discovered the traditional measuring formula to be too conservative and its use almost always resulted in premature exits. Technical literature about these formations provides only a minimum price objective but not an average or most likely target. The classical method used for measuring these reliable and profitable formations is simple and straightforward, but how accurate and reliable is it? Given the limited amount of statistical studies on the subject, I decided to investigate.
For the purpose of this study I found 100 rectangle
formations for the preceding two-year 2004–05 period.
My criterion for including a pattern in the list was a sideways price action bounded by two horizontal or nearly horizontal support & resistance lines. I then made note of the price level of the support & resistance lines, the rectangle duration, slope and volume trend, the price at the breakout above the upper rectangle boundary, and the first short-term top. Other interesting statistics I noted were the volume on the breakout day, the duration, magnitude, and timing of any throwbacks following the initial breakout, and also the direction of any premature or false breakouts. Statistical analysis of the results revealed some surprising findings contradicting some widely accepted principles.