Good sell signals from rectangle formations

Published 17 October 2019

New research results from Investtech show that stocks with sell signals from rectangle formations in the Nordic stock exchanges have given annualised excess return of -13.4 percentage points in the long term, and negative excess return compared to market also in the short and medium term.

Identification of geometric price patterns in stock prices is an important area of technical analysis. The idea is that these patterns describe the investors’ mental state, i.e. whether they will want to sell or buy stocks in the time ahead, and they thereby indicate the future direction of the stock price. Rectangle formations are one type of such patterns.

The development of a rectangle formation indicates that the investors are unsure about the future direction of the stock. The price moves sideways between a support level and a resistance level. A negative signal from a rectangle formation indicates that investor pessimism is increasing and that the stock continues or enters a falling trend. This is especially the case when the stock price is in a falling trend already. The investors have experienced a new negative surprise which has triggered the signal and fear is growing.

Investtech’s algorithms identify such formations for you. In our price charts, rectangle formations are shown by code REC and, in the case of sell signals, a red downward arrow. The arrow shows theoretical price target. A current example may be for instance Prosafe, which triggered a negative signal from a rectangle formation on Oct 3.

Figure 1: Prosafe (PRS.OL) Close: 7.93 (-0.23), Oct 16, 2019

Our subscribers can find stocks with these signals using for instance the tool Signals.

We wanted to see what statistical results these sell signals have yielded and therefore studied return from Norwegian, Swedish, Danish and Finnish stocks following buy and sell signals from rectangle formations identified in Investtech’s price charts in the short, medium and long term. We had up to 23 years of data, from 1996 to 2018.

The chart below shows average price development following sell signals from rectangle formations identified in Investtech’s long term price charts in the Nordic markets. The signals are triggered on day 0. Only days when the exchange is open are included, so 66 days equal approximately three months. The thick red line shows the development of sell signal stocks. The shaded areas are the standard deviation of the calculations. The thin red line shows benchmark development in the same period as the sell signal stocks.

Figure 2: Sell signal from rectangle formations, Norway, Sweden, Denmark and Finland combined, long term, 1996-2018.

Sell signals from rectangle formations in the short term have given an excess return of -0.6 percentage points in one month, equal to an annualised excess return of -6.8 percentage points.

Sell signals from rectangle formations in the medium term have given an excess return of -1.2 percentage points in three months, equal to an annualised excess return of -4.9 percentage points.

In the long term, sell signals from rectangle formations have given an excess return of -3.6 percentage points in three months, equal to an annualised excess return of -13.4 percentage points.

Our research shows high likelihood that signals from rectangle formations in Investtech’s price charts will continue to give good indications about future price development. Stocks with sell signals from rectangle formations are statistically expected to continue to underperform vs the market.

Please find more details and results in the research reports here:

Rectangle formations, short term

Rectangle formations, medium term

Rectangle formations, long term