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Thomas Bulkowski’s successful investment activities allowed him to retire at age 36. He is an internationally known author and trader with 30+ years of stock market experience and widely regarded as a leading expert on chart patterns. He may be reached at

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Bulkowski's Rectangle Top Setup

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This article discusses trading rectangle top chart patterns using a new setup.

 

Rectangle Top Setup Summary

If you can recognize a rectangle top in time to use this trading setup, it can result in a profitable trade 75% of the time.

Set a buy stop a penny above the top of a rectangle top chart pattern and above a 21-day simple moving average. When price breaks out of the chart pattern, the stop should get you in. Sell at the close three trading days later. The setup makes, on average, over 3% in 5 calendar days with a win/loss ratio of over 7. Yes, 7.

Rectangle Top Setup Background

Rectangle top chart pattern

The figure on the right is the ideal rectangle top chart pattern. Price enters the pattern from the bottom and bounces between two horizontal or nearly horizontal trendlines. In this example, price exits the rectangle top from the bottom but it need not. In fact, testing shows the breakout is upward 68% of the time.

The trading setup that follows assumes, and looks for, upward breakouts only.

 

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Rectangle Top Setup Methodology

Since I have used these same tests on other chart patterns, I dispensed with in-sample tests and just used out of sample. This was also necessary because of the scarcity of rectangle top chart patterns in my database.

I conducted tests on about 1,550 stocks going back as far as mid 1991 and as recent as June 2010. I only used chart patterns that I have found, not those located by an automated program. Thus, the rectangle tops are known valid chart patterns.

The following tests reveal short-term trading setups, not buy and hold situations.

Each trade assumes a starting portfolio value of $10,000. Commissions of $10 each way ($20 round trip) are included, but no allowance for slippage, taxes, fees, and so on. Any profits were not reinvested in the next trade.

Rectangle Top Setup Results

The various results from the tests are listed below and an explanation of each test is in the next section. Here are the column definitions.

The Rank column is a rank of the sum of the ranks of many but not all of the columns. The sum with the lowest total is the best. The best performing test is listed first.

The Per Trade Avg P/L columns are the average profit or loss per trade in dollars and percent, based on an investment of $10,000 per trade minus $10 for commissions each trade ($20 round trip).

% Wins is the percentage of winning trades. Avg Win is the average of all winning trades. Avg Loss is the average of all losing trades. W/L Ratio is the average win divided by the average loss. If losses are larger than the average win, then the value will be negative.

Max Drawdown is the largest equity drop from peak to valley during the trade. It represents how much profit you give back (worst case). Hold Time Loss is the maximum drop below the buy price during the trade. It represents how much money you could have lost if you sold when price toped. Hold Time is the average time the stock was held. # Trades is the number of trades counted in the test.

Items shown in red are ranked best in that column.

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Rank 
Test
Per Trade
Avg P/L
Per Trade
Avg P/L
%
Wins
Avg
Win
Avg
Loss
W/L
Ratio
Max
Drawdown
Hold
Time Loss
Hold
Time
#
Trades
1.Buy price >21 day SMA, 3 day exit $309.66 3.1%75% $360.21  $50.54 7.1328%16%5599
2.Buy price <200 day SMA, 3 day exit $336.05 3.4%76% $414.82  $78.78 5.2719%11%554
3.3 day or 5% exit, no stop $263.79 2.6%78% $312.32  $48.50 6.4411%16%4602
4.Buy price >50 day SMA, 3 day exit $304.84 3.0%75% $359.38  $54.54 6.5928%16%5599
5.2 day exit $278.33 2.8%74% $328.72  $50.39 6.5216%16%4602
6.5% profit, stop at halfway between buy price and fmtn low $319.63 3.2%79% $415.34  $95.72 4.3414%10%11602
7.3 day exit $320.69 3.2%75% $358.41  $55.72 6.4328%16%5602
8.Buy price >200 day SMA, 3 day exit $297.07 3.0%75% $351.07  $53.99 6.5028%16%5542
9.5% profit, stop: fmtn-.01 $336.36 3.4%86% $450.33  $113.97 3.9521%16%15602
10.2 day exit, stop is buy day's low-.01 $261.43 2.6%70% $319.17  $57.74 5.5316%9%4602
11.3 day exit, stop at low on buy date-.01 $340.79 3.4%68% $340.79  $67.43 5.0528%9%5602
12.3 day exit. Stop: lower of today or yesterday -.01 $298.37 3.0%74% $357.77  $59.41 6.0228%11%5602
Rank 
Test
Per Trade
Avg P/L
Per Trade
Avg P/L
%
Wins
Avg
Win
Avg
Loss
W/L
Ratio
Max
Drawdown
Hold
Time Loss
Hold
Time
#
Trades
13.6% profit exit, stop: fmtn-.01 $395.87 4.0%84% $522.28  $126.41 4.1326%18%19602
14.4 day exit $385.03 3.9%75% $385.03  $54.56 7.0641%23%7602
15.7% profit exit, stop: fmtn-.01 $432.58 4.3%82% $582.42  $149.85 3.8926%18%23602
16.5 day exit $352.33 3.5%75% $416.83  $64.60 6.4541%23%8602
17.8% profit exit, stop: fmtn-.01 $449.95 4.5%79% $641.31  $191.36 3.3526%18%28602
18.5% profit, stop at buy day's low -.01 $246.99 2.5%63% $336.10  $89.11 3.7714%9%7602
19.Exit day after a lower close $170.91 1.7%69% $303.58  $132.67 2.2919%8%5602
20.10% profit, stop at buy day's low -.01 $331.99 3.3%47% $481.30  $149.31 3.2228%11%16602
21.9% profit exit, stop: fmtn-.01 $478.50 4.8%76% $698.61  $220.11 3.1729%25%32602
22.Exit day after a lower low $185.93 1.9%68% $327.32  $141.39 2.3221%9%6602
23.10% profit exit, stop: fmtn-.01 $500.26 5.0%74% $747.07  $246.81 3.0335%25%36602
24.Exit day after a lower high $177.87 1.8%68% $319.53  $141.66 2.2621%23%5602
Rank 
Test
Per Trade
Avg P/L
Per Trade
Avg P/L
%
Wins
Avg
Win
Avg
Loss
W/L
Ratio
Max
Drawdown
Hold
Time Loss
Hold
Time
#
Trades

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Rectangle Top Setup Test Explanation

Unless otherwise specified, trade entry uses a buy stop a penny above the top of the formation (a penny above the highest high in the chart pattern). For the exit, sell at the close (as in the case of "3 day exit," for example) or the opening price the day after the exit signal. "Buy price >200 day SMA, 3 day exit," for example, means to set a buy stop a penny above the top of the rectangle only if that price is above the 200-day simple moving average (SMA) on the buy day. Once into the trade (day 1), sell at the close of day 4.

  • 1. Enter when the buy price is above the 21-day SMA, Exit at the close in 3 trading days. This ties for the best performing setup, according to the rankings
  • 2. Buy if price is below the 200-day simple moving average and exit at the close in 3 trading days. This ties with the above for the best performing setup.
  • 3. Exit at the close in 3 trading days or if price climbs at least 5%, whichever comes first. No stop is used.
  • 4. Buy price is above the 50-day SMA. Exit at the close in 3 trading days.
  • 5. Exit at the close in 2 trading days, no stop.
  • 6. Exit on 5% profit, place a stop halfway between the buy price and formation low.
  • 7. Exit at the close in 3 trading days. No stop used.
  • 8. Buy if price is above the 200-day SMA. Exit at the close in 3 trading days.
  • 9. Exit after 5% profit, use a stop placed a penny below the formation low.
  • 10. Exit at the close in 2 trading days, and use a stop placed a penny below the low on the buy date.
  • 11. Exit at the close in 3 trading days, and use a stop placed a penny below the low on the buy date.
  • 12. Exit at the close in 3 trading days. Use the lower of today's or yesterday's low minus a penny as the stop price.
  • 13. Exit on 6% profit Use a stop a penny below the formation low.
  • 14. Exit at the close in 4 trading days with no stop used.
  • 15. Exit on 7% profit. Use a stop a penny below the formation low.
  • 16. Exit at the close in 5 trading days with no stop used.
  • 17. Exit on 8% profit. Use a stop a penny below the formation low.
  • 18. Exit on 5% profit. Place a stop a penny below the low on the buy date.
  • 19. Exit at the opening price the day after a lower close.
  • 20. Exit after 10% profit, and use a stop placed a penny below the low on the buy date.
  • 21. Place a stop loss order a penny below the formation's low, and exit on 9% profit.
  • 22. Exit at the opening price the day after a lower low.
  • 23. Exit after 10% profit, and use a stop loss order a penny below the formation's low
  • 24. Exit at the opening price the day after a lower high. This is the worst performing test of the bunch.
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Rectangle Top Setup Trading Example

Picture of Fortune Brands (FO) on the daily scale.

I show Fortune Brands (FO) on the daily scale with a rectangle that appears in March to April 2010.

Price moves horizontally, touching or coming close to the bottom and top trendlines several times, but still looking irregular. This might also work as a descending triangle.

With a price buy price set a penny above the top of the chart pattern, it triggers on April 9 at 50.09. Since price is above the 21-trading day simple moving average, (incidentally, the 21-day was chosen in tests simply because that's how many days are in the average trading month and for no other reason), it qualifies as a valid buy according to the best ranked trading setup.

A sell occurs at the closing price three trading days later, April 14, at 52.37 for a gain of $436, or a 4.4% gain on a $10,000 investment in 5 calendar days.

-- Thomas Bulkowski

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See Also

Written by and copyright © 2005-2017 by Thomas N. Bulkowski. All rights reserved. Disclaimer: You alone are responsible for your investment decisions. See Privacy/Disclaimer for more information. Show me a man who is a good loser, and I'll show you a man who is playing golf with his boss.