Exclusive research report: Rectangles and return from breakouts

Published April 24, 2019

In technical analysis there are only two independent factors, price and volume, that can be studied on their own. Now in price itself can be found many patterns that can be used as a good entry or exit tool. And to accompany such patterns, volume is another factor that one must not forget at any point. Volume reflects the quality of the breakout, if there is overweight of buyers or sellers.

A rectangle formation is one of the most popular and easy to identify price patterns that are created when buyers and sellers of the stock are balanced over time. In other words, one can say there is indecisiveness among investors and traders as to which way the price should move. Hence a sideways move.

Technical analysis theory suggests that investor psychology is about to change when the price breaks out from such formations. Such breakouts are considered stronger if they are accompanied by a surge in volume whether its a buy or a sell signal. Target from the formation (as shown in the image below) is the height of the formation projected from the point of breakout/breakdown.

Figure 3: A stock develops a rectangle formation when the price moves sideways between a support line and a resistance line. If the price breaks up from the rectangle, it triggers a buy signal, and according to technical analysis theory the stock price will rise at least as much as the height of the formation. If the price breaks downwards, it triggers a sell signal, and the stock price will fall accordingly.

Investtech's Research:

Background and outcome: A report based on 12 years of data from the National Stock Exchange in India shows that stocks with buy signal (3,717 buy signals identified) from rectangle formations on average have risen by 4.9 per cent after three months, while stocks with sell signal (3,004 sell signals identified) from rectangle formations have fallen 0.5 per cent. There is an excess return of 1.8 percentage points compared to benchmark, which on average increased by 3.1 per cent.

Below is the graph that shows results from Investtech's automatic algorithms in medium term charts. The signals are triggered on day 0. Only days when the exchange is open are included, so 66 days equal approximately 3 months. Buy signals are the blue line and the sell signals are the red one. The shaded areas show the standard deviation for these calculations. The black line is the benchmark index.

Rectangle formations and average benchmark

Annualized return: The table below shows annualized return and excess return in percentage points (%p). Annualized return is calculated by repeating the 66 day return four times. Excess return is calculated by subtracting average 66 day return of benchmark index four times. Buy signals gave an annualized excess return of 8.0 percentage points, while sell signals gave negative returns of 15 percentage points with respect to the benchmark Nifty 50 index.

%p: percentage points

Our opinion: Based on historical prices for stocks on the National Stock Exchange in the period 2007 to 2018, stocks with buy signals from rectangle formations have clearly outperformed benchmark the following three months. Similarly, stocks with sell signals from rectangle formations have underperformed.

Complete report available here.

As you navigate through our menu on the Indian page of our website, you can click on 'signals' and choose between positive or negative stocks, breakouts from different price formations and different time frames. This will give you an overview of stocks that match with your preset criteria.

On the same note we now analyze two stocks that have recently given breakout from rectangle formations.

ABB India Limited (ABB.NS) Close: 372.20

Motilal Oswal Financia (MOTILALOFS.NS) Close: 1057.95