The Rectangle Top pattern forms when the price of a security is stuck in a rangebound motion, and it bounces between support and resistance levels. Two horizontal lines are formed (top: 1, 3, 5) and (bottom: 2, 4) as a result. Depending on who gives up first – buyers or sellers – the price can Breakout in either direction.
This pattern is commonly associated with directionless markets. Usually the pattern performs better when there is a strong uptrend leading into the formation.
Trade idea
If price breaks out from the bottom pattern boundary, day traders and swing traders should trade with a DOWN trend. Consider selling a security short or buying a put option at the downward breakout price level. To identify an exit, calculate the pattern height by taking the difference between the support and resistance levels. Then, subtract the pattern height from the breakout price to estimate the target price.
To limit potential loss when price suddenly goes in the wrong direction, consider placing a stop order to buy back a short position or sell a put option at or above the breakout price.