A rectangle is a pattern that forms as an asset trades in a range, during a pause in the trend.

The pattern is easily identifiable by at least two comparable highs and two comparable lows. The highs and lows can be connected to form two parallel lines that make up the top and bottom of a rectangle. The pattern is not complete until a breakout or a breakdown has occurred. Although sometimes clues can be found, the direction of the breakout or is usually not determinable beforehand. Things to remember with rectangles:

At least two equivalent highs are required to form the upper resistance line and two equivalent lows to form the lower support line. They do not have to be exactly equal, but should be within a reasonable proximity. Although not a prerequisite, it is preferable that the highs and lows alternate.

Rectangles can extend for a few weeks or many months. If the pattern is less than 3 weeks, it is usually not considered a rectangle. Ideally, rectangles will develop over a multi-month period. Generally, the longer the pattern, the more significant the breakout. For example, a 3-month pattern might be expected to fulfill its breakout projection. However, a 6-month pattern might be expected to exceed its breakout target. The direction of the next significant move can only be determined after the breakout has occurred. In other words, rectangles are neutral patterns that are dependent on the direction of the future breakout. Volume patterns can sometimes offer clues, but there is no confirmation until an actual break above resistance or break below support.

• For a breakout to be considered valid, it should be on a closing basis. One basic tenet of technical analysis is that broken support turns into potential resistance and visa versa. After a break above resistance (or below support), there is sometimes a return to test this newfound support level (or resistance level). A return to or near the original breakout level can offer a second chance to enter a trade.

Rectangles represent a trading range that pits the bulls against the bears. As the price nears support, buyers step in and push the price higher. As the price nears resistance, bears take over and force the price lower. More active traders will sometimes play these bounces by buying near support and selling near resistance. Eventually either the bulls or bears will exhaust themselves and a winner will emerge when there is a breakout.

Again, it is important to remember that rectangles have a neutral bias. Even though there can be a tendency to try to predict the breakout, the actual price action depicts a market in conflict. Only until the price breaks above resistance or below support will it be clear which group has won the battle and a trade can be entered.

Take a look at this chart of Spotify (SPOT):

(Source: Yahoo! Finance)

As you can see in the chart of above, SPOT was trading within a rectangle pattern. The resistance of the pattern was at $198 and the support for the rectangle was at $178. Traders could have “played the range” and bought at support and shorted at resistance. And as we can see, when SPOT crossed above the resistance level, a breakout occurred.

The cup and handle is a bullish continuation pattern that marks a consolidation period followed by a breakout. As its name implies, there are two parts to the pattern: the cup and the handle.

The cup forms after an advance and looks like a bowl or “rounding bottom”. As the cup is completed, a trading range develops on the right hand side and the handle is formed. A subsequent breakout from the handle's trading range, and through the resistance created by the cup, usually signals a continuation of the prior advance.

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Here are few things to remember with cup and handle patterns:

• To qualify as a continuation pattern, a prior trend higher should exist. Ideally, the trend should be a few months old, but not too mature. Ideally, the depth of the cup should retrace 1/3 or less of the previous advance. However, with volatile markets and over-reactions, the retracement could range from 1/3 to 1/2. In some rare situations, the maximum retracement could be as much as 2/3 of the previous trend.
• The cup should be "U" shaped or resemble a bowl or rounding bottom. A "V" shaped bottom would be considered too sharp of a reversal, thus would not meet the definition of a cup. The ideal pattern would have equal highs on both sides of the cup, but this is not always the case.
• After the high forms on the right side of the cup, there is a pullback that forms the handle. Sometimes this handle resembles a flag that slopes downward, but other times it is just a short pullback. The handle represents the final consolidation before the big breakout and can retrace up to 1/3 of the cup's advance, but usually not more. The smaller the retracement, the more bullish the formation and significant the breakout. Sometimes it is prudent to wait for a break above the resistance line established by the highs of the cup.
• The cup can extend for days, weeks or months.

As with most chart patterns, it is more important to capture the essence of the pattern than the particulars. The cup is a bowl-shaped consolidation and the handle is a short pullback followed by a breakout.

Take a look at this chart of Pan American Silver (PAAS):

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As you can see in this chart above, PAAS formed a well defined cup and handle pattern. The stock had the necessary uptrend in May leading into the formation of the cup, which formed in June. The handle was formed the first week of July, and the breakout occurred above the resistance line on July 8th.

A head and shoulders reversal pattern forms after an uptrend, and its completion marks the reversal of the preceding trend. The pattern contains three successive peaks with the middle peak (head) being the highest and the two outside peaks (shoulders) being low and roughly equal. The support lows of each peak are called the “neckline”. A few things about head and shoulders:

• It is important to establish the existence of a prior uptrend for this to be a reversal pattern. Without a prior uptrend to reverse, there cannot be a head and shoulders reversal pattern.
• While in an uptrend, the left shoulder forms a peak that marks the high point of the current trend. After making this peak, a decline ensues to complete the formation of the left shoulder.
• From the low of the left shoulder, a rally begins that exceeds the left shoulder high and eventually marks the top of the head. After the head formation peaks, the low of the following decline marks the second point for the formation of the neckline.
• The advance from the low of the head forms the right shoulder. This peak is lower than the head (a lower high) and usually in line with the high of the left shoulder. While symmetry is preferred, sometimes the shoulders can be out of whack. The decline from the peak of the right shoulder should break the neckline.
• The neckline forms by connecting the low point of the left shoulder decline with the low point of the head decline. Depending on the relationship between the two low points, the neckline can slope up, slope down or be horizontal. Sometimes more than one low point can be used to form the neckline.
• The head and shoulders pattern is not complete and the uptrend is not reversed until neckline support is broken. Ideally, this should also occur in a convincing manner, with a large increase in volume. The volume increase adds validity to the breakdown.
• Once support (neckline) is broken, it is common for this same support level to then turn into resistance on any rallies. Sometimes, but certainly not always, this return to the support break area will offer a second chance to sell or enter a short trade.

Take a look at this chart of PagSeguro Digital (PAGS):

(Source: Yahoo! Finance)

As you can see from the chart of PAGS, the stock formed a well defined head and shoulders pattern. The stock had the necessary uptrend leading into the formation of the pattern and the pattern itself is clear (blue). The “neckline” that was created by the head and shoulders pattern was $42.50.

When the neckline was broken, a breakdown occurred on a high increase in volume. The stock then continued lower for some time.

A price channel is a continuation pattern that trends up or down and is bound by an upper and lower trend line. The upper trend line marks resistance and the lower trend line marks support. Price channels with negative slopes (downward) are considered bearish and those with positive slopes (upward) bullish. For explanatory purposes, an uptrending price channel will refer to a channel with positive slope and a downtrending price channel will refer to one with a negative slope. Here are several things to consider with price channels:

• It takes at least two points to draw the main trend line. This line sets the tone for the trend and the slope. For an uptrending price channel, the main trend line extends up and at least two reaction lows are required to draw it (support). For a downtrending price channel, the main trend line extends down and at least two reaction highs are required to draw it (resistance).
• The line drawn parallel to the main trend line will be the resistance for uptrending price channel and the support for the downtrending price channel. Ideally, the channel line will be based off of two opposite highs or lows. However, after the main trend line has been established, some analysts draw the parallel channel line using only one reaction high or low.
• For uptrending channels, as long as prices advance and trade within the channel, the trend is considered bullish. The first warning of a trend change occurs when prices fall short of channel line resistance. A subsequent break below main trend line support would provide further indication of a trend change. A break above channel line resistance would be bullish and indicate an acceleration of the advance.
• For downtrending channels, as long as prices decline and trade within the channel, the trend is considered bearish. The first warning of a trend change occurs when prices fail to reach channel line support. A subsequent break above main trend line resistance would provide further indication of a trend change. A break below channel line support would be bearish and indicate an acceleration of the decline.

In a bullish price channel, more active traders look to buy when prices reach main trend line support. Conversely, some traders look to sell (or short) when prices reach main trend line resistance in a bearish price channel.

Because technical analysis is just as much art as it is science, there is room for flexibility. Even though exact trend line touches are ideal, it is up to each individual to judge the relevance and placement of both the main trend line and the channel line.

Take a look at this chart of Nutanix (NTNX):

In this chart we see that NTNX is trading within a downtrending price channel. The channel resistance currently sits near $23 and the channel support sits right under $20.

Traders could look to enter a short position on a test of the channel resistance and/or if NTNX breaks below the channel support. By the same token, a trader could enter a long trade on a pullback to the channel support and/or on a breakout through the channel resistance.

The ascending triangle is a bullish formation that usually forms during an uptrend as a continuation pattern. There are instances when ascending triangles form as reversal patterns at the end of an uptrend, but they are typically continuation patterns.

Because of its shape, the pattern can also be referred to as a right-angle triangle. Two or more comparable highs are needed form a horizontal resistance level. And to form a rising/ascending trend line of support, the stock must decrease in price, but each time this happens, the decrease in price should be smaller.

Here are some key factors to consider with descending triangles:

• At least 2 highs are required to form the higher horizontal resistance level. The highs do not have to be exact, but should be within reasonable proximity of each other.
• To form the ascending trendline, the stock price must decrease at least 2 times, each time less than it did previously. If a more recent low is equal to or greater than the previous low, then the ascending triangle is not valid.
• The length of the pattern can range from a few weeks to many months, with the average pattern lasting from 1-3 months. The bigger the pattern, the bigger the subsequent move on the breakout or breakdown.
• As stated earlier, a basic tenet of technical analysis is that broken resistance commonly turns into support and visa versa. So, if the horizontal resistance level of the ascending triangle is broken, it turns into support. Sometimes there will be a return to this newfound support level before the up move begins in earnest.

A ascending triangle definitely has a bullish bias before the actual break, but the pattern must be given the latitude to break lower as well. This is why it is important to let the pattern develop.

The reason why the bullish bias is assumed is because the horizontal resistance level represents demand that prevents the security from rising past a certain level. It is as if a large sell order has been placed at this level and it is taking a number of weeks or months to execute, thus preventing the price from rising further.

It is these lower lows that indicate increased buying pressure and give the ascending triangle its bullish bias.

Take a look at this chart of American International Group (AIG):

In this chart, the triangle’s ascending trendline of support begins to establish itself in March and April. And a resistance level is formed after $27.50 is tested a second time in April. As you can see, lower lows begin occurring throughout April and May but the resistance level is not able to be broken until May 18th.

When the resistance level is broken, AIG doesn’t immediately breakout but notice how the $27.50 resistance level turns into support for 5 days and then the stock has a significant breakout to almost $40.

What Should You Do Next?

The chart patterns featured in this report were selected by Christian Tharp who is a Chartered Market Technician (CMT). Every day Christian scans the market looking for the best chart setups to add to his POWR Charts trading service.

See the current 5 to 7 timely trades in his portfolio by clicking the link below.

POWR Charts portfolio