The Rounding Top Pattern is a chart formation that many traders use in order to determine when it’s time to sell. It can be used for both bullish and bearish markets. This article will cover how you can trade with the rounding top pattern, including the different types of trading strategies you should use at various points in the pattern.
What is the rounding top pattern in trading?
A rounding top pattern is a technical trading term that refers to the price chart of an investment vehicle, typically stocks, indexes or forex currency pairs.
The rounded bullish peaks mark the end of one trend and the start of another. It occurs when a stock makes a sharp move up, then pulls back and forms the rounded peak.
The rounding top pattern is made up of a series of price candle peaks that form waves. After connecting each price peak, you’ll see a cone or dome-like design on your chart.
The peaks should be symmetrical with each other while the distance between them increases over time which is an indication of slowing momentum.
It means that after reaching its high point or resistance level, price action will start to decline in value until it reaches a strong level of support.
Why do people use it as an indicator of market direction?
The rounding top pattern in trading can be used to predict when a market is about to make an abrupt move. It’s also often called the dome or cone pattern because of its shape.
As you might guess, this type of price action foreshadows a sharp decline in value for the security, which reverses direction and begins trending downward. It’s also known as a “top reversal.”
The rounding top pattern is a good technical analysis strategy because it is reliable and has strong predictive power. It works well as a leading indicator to spot potential turning points in the market before they happen. This can give you an advantage over other traders.
-One reason traders are interested in the pattern is that it tells them when an asset’s price has reached its top better than other trading methods.
-This pattern is very easy to spot because there is a distinct shape, and the price movement after each peak forms an upward then downward angle.
The rounded top pattern predicts that an uptrend will soon turn into a downtrend, making it valuable for traders who want to go short on the currency pair.
There are many different types of trend reversal patterns that people use, but this one gives us more insight into what’s going on with the market.
How to spot a rounding top stock pattern?
The rounding top is one of the most powerful patterns in technical analysis. The pattern has a long history, and it was used successfully by traders to predict both bearish and bullish trends.
The pattern is characterized by a steep decline in prices, followed by a gradual price increase. This price action forms a perfect inverted U curve with the top of the pattern resembling a rounding shape.
There are Three types of rounding top formations that can happen: ascending and descending.
Descending rounding top: (inverted rounding bottom pattern)
This type of pattern forms in a clear-down trend. There are three consecutive peaks where each one has lower highs than its predecessor; the low peaks resemble a rounded shape, and they can be identified easily.
This type of curve is less common, but it does have bearish predictions.
Ascending rounding top: (bullish rounding top)
Similar to the symmetrical pattern, this formation starts with an increase in prices, followed by a decrease that flattens out. This formation happens in a clear-up trend. Price bounces from the upward sloping up trend line and uses it as a support line.
This type of curve is the one that is the most common and also has a bullish upward breakout. In other words it’s a bullish continuation pattern.
Symmetrical rounding top:
Here the pattern starts with a rise in the stock price. The market then becomes undecided. At this point, it started to stabilize by forming the flat or slightly downward-sloping top. The last phase takes the shape of an inverted U curve with a rounded turn at its right side.
Generally, symmetrical rounding top formation takes too much time than descending or ascending rounding top chart pattern. And most of the time, it breaks to the downside.
How to trade the rounding top pattern?
Rounding top patterns tend to form in the course of an uptrend when prices reach a high level but fail to close well above their highs for several days or weeks at a time. Eventually, they begin forming lower lows, and this fails to hold as well, resulting in price breaking below even these new lows.
The rounding top is a trend reversal pattern, and therefore one should enter the market on the short side. Trading this chart pattern can be accomplished by taking the following steps:
– Identify where rounding tops are forming on your chart(s) – note that they typically form in an up-trending market over several days or weeks after prices reach a high level but fail to close well above their highs.
– Wait for prices to break below the low point of the rounding top formation and then sell short as the price trades under a significant trend line moves lower.
– Use a stop-loss order just above the high point marking the beginning of this chart pattern, or better yet, use risk management techniques such as scaling out partial profits at predetermined levels so you can take some profits off the table while they are still available.
– But once the trade comes in your favor, you can trail down your stop loss. You can trail it just above the low point of the pattern, but make sure you are giving the trade enough room to breathe.
– If you are an aggressive trader, then you can add more lot to the short possession. But keep in mind the rounding top can reverse. And if you are lucky enough, it can form an inverse cup and handle chart pattern with a slight retracement, and then it will come in your favor.
-But if you are not an aggressive trader, then I assume you will wait for the rounding top’s bottom support line breakout and a retest of that support (now it has turned into resistance) for confirmation.
In this way, if that pattern turns into an ascending one, you have a chance to take an opposite buy trade once it breaks the peak of the dome.
Trading strategies for the rounding top pattern
To trade rounding top patterns, we can set our trading strategy considering three factors
Momentum indicators and divergence
Support and Resistance
Momentum indicators and divergence
As we know, any chart pattern is identified by drawing trend lines on the chart. After that, your trading strategy should consider momentum indicators for confirmation of good trading opportunities. This is the point where different traders make different decisions about trading rounded top patterns.
Some traders use two momentum indicators to validate patterns. However, it can be better to use two momentum indicators to identify correct trading opportunities. This will validate the credibility of support and resistance and keep trades safe from false signals.
We have used moving average convergence divergence (MACD) and Relative Strength Index (RSI) as a momentum indicator in our example.
For ascending rounding top, if we see any hidden divergence, then it’s an indication of the trend continuation. In that case, traders should consider it as a buy signal to trades.
strategy to trade rounding top using Support and Resistance
The price of any security has some demand and supply zone. These zones are commonly known as support and resistance.
A support line forms when traders buy at a particular price level, creating an area where buyers are willing and able to purchase more shares than sellers. Similarly, a resistance line forms when traders sell at a particular price level, creating an area where sellers outweigh buyers.
You can view those as price floors and ceilings, where the demand is higher than the supply, and prices will bounce up and down according to where there is more buying or selling pressure.
You can spot those by taking horizontal lines from the points the price bounces several times.
For trading rounding top chart pattern using support line, we can use the neckline as the demand zone. If the price trades below the line, then it’s a sell signal.
On the other hand, the dome top pattern can be used as a resistance zone. Once the price gets above the zone, it’s a buy signal to trade.
Rounding Top Breakout Trading
Breakout trading is the strategy of a rounding top pattern that is very much similar to support and resistance trading. But hear traders wait for the volume spike with a large candle while breaking the support or resistance.
As a moderate trader, I prefer to wait for the resistance line break and retest that resistance line. In addition, the breakout candle (if possible) should be backed by a significant rise in volume. And finally, the cherry on the top – The relative Strength Index line should fall below the 50 levels.
The same thing goes for the buying signal. In that case, the price has to break the support line on the top, a retest, a volume confirmation, and the RSI signal line should go above the 50 Levels.
The Idea of this breakout treading style comes because some aggressive traders do not wait for the breakouts or stock pullback. Generally, they are biased to the bull side.
They get into a buy trade after a 32% retracement from the rounding top’s height. This is a risky trading style because the market can range for several days or even weeks. Moreover, it may break to the downside.
Rounding tops are not always bad news
Rounding tops are not always Bearish patterns. The pattern can often resolve in a bullish too. That makes it an important indicator in your arsenal when you’re looking for potential swing set-ups to trade.
A rounding top should provide a clue as to where the price is going. It’s almost like a speedometer on your car. The needle indicates the speed at which you’re traveling, and it can help you make decisions about where to go from there.
According to Bulkowski, a rounding top can break to the upside 53 Percent of the time and breaks to the downside 47 Percent of the time. The conclusion came after observing 950 Trades over time.
So, for trading bullish or bearish Rounding tops patterns, a trader must wait and observe the breakout side of the pattern very carefully.
Rounding Top Pattern Price Target
After spotting a rounding top, you should measure the length by drawing a line on your mt4 chart between the neckline and the dome’s peak. That is the price measurement for your profit target.
Once the price breaks the support line, put that line down from the neckline. The endpoint of the line is your price target. On the other hand, if the price breaks to the upside of the dome, the same measurement technique is applied. Draw the distance between the peak and the bottom and put that measurement line on the top of the peak. Again, the endpoint is your profit target price.
Like I said earlier, rounding top chart pattern is like a speedo meter of your car, and the needle is your measuring target.
There is another thought about the price target for rounding top chart pattern. As per Bulkowski, the bullish rounding top pattern generally has a bullish movement of about 53 percent; on the other hand, the bearish rounding top will fall around 17 percent from the bottom of the pattern.
When the pattern is complete and the price breaks below the trendline, we’re attempting to capture a surge in momentum as the rounding bottom breakout happens.
The most popular safest strategy is to use targets as close to 2 to 3 times your stop loss to have a good risk-reward ratio. Or, if you are a shorter-term trader who is comfortable with the ebb and flow in your position, you can move your stop to break even as its first target is achieved.
This way, you may be tempted to make more gains and make your risk-reward ratio even higher.
Relationship Between Rounding Bottom and Rounding Top Chart Pattern
Rounding top and rounding bottom chart patterns are similar in the sense that they both indicate a period of consolidation, or balance, before continuing with the price trend.
However, rounding bottoms and rounding tops differ because the shape which results from them has different implications for an analyst.
A rounding bottom is considered a bullish pattern indicating a reversal of a downtrend and possibly the beginning of an uptrend. The pattern occurs when prices make lower lows and then begin to rise, making each successive low higher than the last.
This rising “low” forms what looks like a rounded bottom on the chart, hence its name. A top rounded by higher highs followed by lower highs indicates that prices are peaking before reversing the trend down.
How do I manage my Rounding Bottom trade?
When the pattern is finished, and the price crosses the trendline, we’re attempting to capitalize on a surge in momentum as the rounding bottom chart pattern breakout occurs.
The most popular strategy is to use targets that are as close as 2 to 3 times your stop loss in order to have a good risk-reward ratio. Or if you are a shorter-term trader who is comfortable with the ebb and flow in your position you can move your stop to break even as its first target is achieved.
This way you may be tempted to make more gains and make your risk-reward ratio even higher.
Traits that increase the historical effectiveness of the Rounding Top and Bottom Pattern
Here are 2 traits that increase the historical effectiveness of the Rounding Top and Bottom Pattern:
1) Large period (weekly/monthly data). I found that when there are weekly or monthly charts used. Then the price rises its historical performance by about 20%. The reason being that people are more emotional at these time scales. Which means they are more likely to make poor decisions. This makes the price go further beyond its normal behavior.
2) Trailing stop loss order 10% below the breakout point. I found that using a trailing stop-loss order increases the pattern’s historical performance by about 15%. The reason being is that it seems people are more likely to use limit orders around the breakout point. So they buy/sell there. Which means they are less likely to buy/sell right after or before the breakout. A trailing stop-loss order means you wait until it goes X% past the breakout point, then buys/sells.
This article will discuss these 2 traits in-depth.
However, my most important finding was that even though all my experiments were with a large period. Weekly/monthly data combined with a trailing stop-loss order. The pattern still got beat up badly on some backtests even though it held its own historically.
Advantage Of rounding top reversal Pattern
The pattern’s major advantage as a technical analysis tool is its ability to be identified by two distinct features. Symmetry and the downward break.
Rounding top patterns are symmetrical in shape, which means that the pattern starts out at a lower position to increase gradually and then declines again to return back to its original low level before increasing further.
This type of motion is not seen with other technical analysis tools, allowing it an advantage over them when trading because traders will know right away that this is a pattern.
The second major advantage of the rounding top as a technical analysis tool is its ability to create breakouts, which can be either upwards or downwards depending on the formation and prediction used for it.
If traders were able to recognize these patterns early enough, they could take action before prices start increasing or decreasing rapidly.
Disadvantage Of rounding top Pattern
The disadvantage of this pattern can have a short life as there is no significant decline in the price. Instead, it continues to rise over time till it breaks through an important level. Which is also a signal of further rise. In other words, it’s more like a continuation pattern.
In some cases, rather than continuing an uptrend, there may be a retracement on the breakout of the rounding top pattern. This is called a ‘three drive’ or ‘reversal.’
The first two drives are upswings, and then a third downswing results in breakouts from consolidation zones. Thus, the first two swings usually indicate the strength of the trend and buyers reaching higher levels. While the third one implies a loss of momentum.