WHAT IS Rectangles
Rectangles refers to a pattern in securities trading in which the price of a security stays within a top and bottom limit. Because the price may move slowly or bounce up and down between the top and bottom price, the graph of prices ends up looking like a rectangle, hence the name.
BREAKING DOWN Rectangles
Rectangles is a term used to describe the graphic pattern on a trader's screen that displays when the price of a security bounces from a hard top price to a hard bottom price. The hard top price is a price above which the stock is unlikely to move. The stock is unlikely to drop below the hard bottom price. The price may bounce as a way of correcting. When the stock hits the bottom price, traders will buy it at that price, which will correct and bring the price up. When it hits the top, traders will sell to take advantage of the top price, which then brings the price down. This is most common when the traders are familiar with the stock and know what the bottom and top limits are, so they know when to sell and buy to take advantage of these limits.
These hard top and bottom limits are in effect over a period of time, but will, of course, trend up as the economy trends up and inflation happens. If an event occurs to push the price above or below the boundary prices, the rectangle may or may not reset itself after this price movement stops. If no event pushes the price out of the rectangle, the rectangle will slowly drift up.
Breaking Out of the Rectangle
Because the rectangle is created by the resistance price, or top price a stock is likely to achieve, and the security price, the bottom price a stock is unlikely to drop below, if a stock breaks out of this rectangle shape, significant movement in price is likely. Inertia keeps the price within those top and bottom boundaries, so if something occurs to break through the inertia to push the price above the top limit or below the bottom limit, that momentum will continue and the price will continue to move away from the boundary of the rectangle. The movement above the top price or below the bottom price may be more rapid and sustained than it would otherwise have been, because whatever event pushed the price out of the rectangle must have been significant enough to continue to push the price in that direction. In addition, the movement is likely to gain momentum as it continues.