Constructing rectangles for breakout hypotheses

A bounded range, then two horizontals

Price usually spends time in a bounded range before a trend is abandoned. That range can be constructed as a rectangle: two roughly parallel horizontals that contain the contest between buyers and sellers until price leaves the box.

Pattern-significance from time and depth

How long a rectangle takes to form, and how deep it is, governs pattern-significance: how much weight the next move is given. A range that lasts hours can be invisible on a daily chart and is typically followed by a move of similar brevity. A range that takes about a year to form is associated with a longer, stronger follow-through.

Prints inside the box do not pick a side

A rectangle can resolve as either a reversal-formation or a continuation-formation. The prints inside the box do not by themselves reveal breakout direction, so the prior trend is assumed still in force until the chart shows otherwise. Until the chart proves a reversal, the pause is treated as a continuation-formation.

Measuring-objective and the price scale

The measuring-objective is the vertical distance between the top and bottom of the pattern, projected from the breakout point in the direction of the break.

On longer-term charts the vertical scale changes that objective. An arithmetic-scale projection of a range between 4 and 10 can land below zero, because equal vertical distances represent equal currency amounts. A logarithmic-scale projection of the same range stays a proportionate swing, because equal vertical distances represent equal percentage changes. The two scales differ little on very short-term charts.

Volume-taper before the break

Volume typically trends from relatively high on the left of the formation toward relatively low on the right as the contest evens out. That volume-taper is the usual background. An upside breakout without a rise in activity is treated as suspect. A downside breakout can occur on light or heavy volume, because prices can fall when bids disappear.

A breakout still has to hold

A breakout is a move through the upper or lower boundary that still has to prove it can hold, and on advances is expected to show expanding activity. A historic rule that treated a 3 percent penetration as a valid breakout is presented as no longer reliable on fast intraday charts. Some traders instead require two consecutive closes, or two bars of the chart’s own interval, beyond the boundary. A move that fails to hold outside the pattern is treated as unproven.

Whips, exits, and retracement

After a whippy breakout, one construction places an exit beyond the prior minor swing and another exits if price recrosses the halfway mark of the pattern’s depth. After a breakout, a retracement is common. A small trendline across the pullback peaks can supply a second confirmation when that line is broken.