The Rectangle Top pattern forms when the price of a security is stuck in a range bound motion. Two horizontal lines (top: 1, 3, 5) and (bottom: 2, 4) form the pattern as the security bounces up and down between support and resistance levels. 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 the price breaks out from the top pattern boundary, day traders and swing traders should trade with an UP trend. Consider buying a security or a call option at the breakout price level. To identify an exit, compute the target price level by adding the pattern height (which is the distance between the horizontal line (from top to bottom) and add it from the breakout price.

To limit potential loss when price suddenly goes in the wrong direction, consider placing a stop order to sell at or below the breakout price.