HOW TO TRADE BEARISH RECTANGLE CHART PATTERN

How to trade bearish rectangle chart pattern
Infographic - How to trade bearish rectangle chart pattern

Entry: after breaking the rectangle's lower border at point (5), either with an entry after the breakout, or after a possible retest of the lower border.

Take profit: identified by measuring the vertical distance between the rectangle's upper and lower borders, that measurement is then applied from the breakout rate (5)

Stop loss: the rectangle's lower border, which is a resistance that turned into support after the breakout.

BEARISH RECTANGLE PRICE ACTION

This chart pattern starts forming with bears already in control of the exchange rate's downtrend. When bulls enter the market, a consolidation period starts and rate gets contained within a specific range, where bulls are creating a resistance at a certain rate, and bears are creating support at a certain rate as well. Bears then break that consolidation, and the exchange rate continues its downtrend.

Let's break down the pattern formation!

In a downtrend, price action finds the first resistance (1), which will be the horizontal resistance for the rest of the pattern formation.

Price action reverses direction from the first resistance (1) and goes upwards till it finds the first support (2), which will be the horizontal support for the rest of the pattern formation.

Price action reverses direction from the first support (2) and goes downwards, till it finds the second resistance (3), which will be around the same rate of the first resistance (1)

Price action reverses direction from the second resistance (3) and goes upwards, till it finds the second support (4), which will be around the same rate of the first support (2)

The pattern is completed when price action reverses direction from the second support (4) and goes downwards till it breaks the rectangle's lower border at point (5)

NOTES ON BEARISH RECTANGLE

Direction

Continuation

Type

Bearish

Occurrence

High

Common term

All

Before the breakout, 4 touches to the rectangle's upper and lower borders are the minimum for a valid pattern, more touches are acceptable.

After the breakout, retesting the rectangle's lower border, which was a resistance that turned to support, is highly possible.

The most common direction of the pattern is a continuation, but that doesn't rule out the existence of reversal rectangles. The target measurement in that case will be applied from the upper border's breakout rate.

Volume usually increases when breaking or retesting the rectangle's lower border (5)

This pattern is commonly found on all time frames.

BEARISH RECTANGLE REWARD:RISK

R:R depends on the (lower border-entry rate) distance, compared to (lower border-upper border) distance.

Always remember that the stop loss level explained above is absolute, the actual stop loss rate for your trade setup should be a bit beyond those levels to give the trade setup some room to breathe, and of course, calculations for position size and R:R should be done with respect to that rate.

BEARISH RECTANGLE REAL TRADE

Bearish rectangle real trading example
Forex chart - Bearish rectangle real trading example, as found on the D1 chart of GBP/JPY using XM's MT4 platform

PRE-BREAKOUT CALCULATIONS

Since a bearish rectangle chart pattern can be spotted after the reversal from point (4), you can save yourself precious time by doing the following set of calculations before the breakout, since they don't rely on the trade's entry rate.

Note: identifying the rectangle's upper and lower border rates is subjective since the rates of points (1) and (3) won't be exactly the same, as well as points (2) and (4). We prefer choosing the point with the higher rate for the lower border, and the point with the lower rate for the upper border to keep the pattern compact, which in this trade are points (2) and (3) respectively.

  • Pattern length (point (2) rate - point (3) rate)
    • (188.288 - 180.648) * 100 = 764.0 pips
  • Take profit rate (breakout rate - pattern length)
    • 180.648 - (764.0 / 100) = 173.008
  • Stop loss rate (breakout rate + 25% of pattern length)
    • 180.648 + ((25 * 764.0 / 100) / 100) = 182.558

TRADE SETUP

Choosing when to enter the trade after the rectangle's lower border breakout is always left to your best judgement. In this trade, we chose to enter the market at the closing rate of the candle right after the candle that broke the lower border, to ensure that the breakout was real, not a fakeout. The breakout candle itself was a very short bearish candle, that closed so close to the rectangle's lower border, which lead to prefer waiting for the next bearish candle.

  • Trade entry rate
    • At the closing rate of the candle right after the candle that broke the lower border at point (5): 179.488
  • Take profit in pips (entry rate - take profit rate)
    • (179.488 - 173.008) * 100 = 648.0 pips
  • Stop loss in pips (stop loss rate - entry rate)
    • (182.558 - 179.488) * 100 = 307.0 pips
  • Stop loss R:R (take profit in pips / stop loss in pips)
    • 648.0 / 307.0 = 2.111

Currency pair

GBP/JPY

Timeframe

D1

Breakout

18-Dec-2015

Platform

MT4

Broker

XM