The battle between the buyers and the sellers dictates the price action. When the buyer overpowers the sellers, a bullish market will form. On the flip side, a bearish market occurs when sellers dominate the market.
But what if neither the buyer nor the seller wins the battle?
The price will pause – it enters market indecision. During this indecision, the price bounces back and forth to certain levels (support and resistance) parallel to one another – forming a rectangle pattern.
In this lesson, you'll learn how to trade price breakouts using the rectangle pattern effectively.
In the forex market, consolidation is the type of market environment where the price of the currency pairs trades on a specific range, known as the support and resistance level.
On the flip side, a breakout occurs when the price trades below the support level or above the resistance level to form its primary trend. This means the price breaks out from the established range, as its name suggests.
Simply put: A breakout happens after a consolidation.
Learn more about different breakouts you can spot on this TradeGeek lesson: TradersUnited - Types of Forex Market Breakouts
The support and resistance (S/R) levels play a very important role in identifying price consolidation and breakout.
S/R levels are the range where the price bounces back and forth during consolidation. When the price trades beyond these levels, the breakout signal is confirmed.
Imagine when you're charting and connecting the highs and the lows – and it forms perfectly horizontal trendlines. But what does this mean?
The market is currently on pause. It's not following any primary trend and is just trading within its support and resistance levels.
The indecisiveness of the buyers and sellers forms this pattern. Uncertain about the market's big move, they test the support and resistance several times to gauge the future price direction.
A price that's not trending is unprofitable. Well, that's a myth.
This pattern's stability doesn't directly mean an unprofitable moment for traders. A rectangle pattern provides a clear support and resistance level that you can use for your trades' entry and exit points.
Moreover, the type of rectangle pattern you've seen indicates the future market trend once a breakout happens.
A bearish rectangle pattern indicates that the price will decline even lower after the consolidation. Meanwhile, a bullish rectangle means the market will have an upward trend after breaking out.
You'll know the profitable and safe entry and exit points if you correctly spot and trade these patterns. If the market moves based on your findings, you'll run at a nice profit.
When the price suddenly stops trading higher and consolidates, it indicates a bullish rectangle formation.
This happens due to these two primary reasons:
Once the pattern is confirmed, the price will continue its upward trend. Typically, you can set the target by measuring the size of the rectangle and plotting it above the resistance level.
A bearish rectangle can be found at the bottom of a depreciating market. After the price consolidates, it will continue its downward movement.
Like its bullish counterpart, consolidation happens due to market indecision. However, the distribution phase could also be the reason behind the consolidation – where traders expect a massive sell-off, thus executing short positions.
If you're selling, you can place the entry point of your short position below the support level – this ensures that you can take advantage of the potential price movement while still being safe in case the signal doesn't push through.
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