If I had to choose a single pattern that represents some of the most accurate trading signals, it would probably be a breakout from a long, narrow sideways consolidation pattern. Rectangles that have contained a security within a narrow range tend to be followed by explosive movements to the upside – if, and only if, the top of that range is taken out. Conversely, downside breakouts from a long rectangle can be quite bearish. I mention two ways to trade rectangles in my book, Sideways, but upside breakouts are by and far the most rewarding of the two. FYI: the other method to trade these patterns is to buy the bottom, and sell the top with coinciding stochastics or RSI signals. Read the book for more details.
When viewing a rectangle breakout, look for at least 3 days and about a 2-3% price increase from the breakout point – along with supportive volume spikes to confirm the movement. If the breakout is legitimate, the movement can be very rewarding for the players on the right side of the trade.
Right now, I’m watching coal – which is well into a very long rectangular consolidation. Check the nice long consolidation pattern on the Market Vectors Coal ETF (KOL) above, which has recently taken out the down trend. If coal breaks out to the upside under the conditions mentioned above, this could be a very big mover. Watch for a breakout through about $26/share (a catalyst such as positive economic news coming out of China might inspire such a move) to drive KOL up out of its sideways trading range. While there is always potential for a downside breakout through $22/share, the fact that KOL has broken its downtrend hints that any eventual breakout might be a bullish one. This one, while not yet ready to buy, deserves a place on a traders watch list.