A classical bearish reversal pattern is a rounding top that forms at the end of an uptrend. The pattern reflects the gradual shift in momentum within the uptrend, when it starts to slow and ultimately rolls over into a downtrend. Unlike the abrupt changes in momentum seen with patterns like head and shoulders, the rounding top occurs over a longer period of time, allowing traders greater time to adapt their position.
How to Identify the Rounding Top Pattern
The rounding top is difficult to discern on a chart as it often starts to take on the appearance of a head and shoulders pattern. However, unlike a head and shoulders, the rounding top usually doesn’t create the typical shoulders and head, and the highs begin to contract. In a mature pattern, price action forms a smooth curve, almost an inverted parabola, that tells of the gradual loss of upward momentum.
To correctly identify the pattern, you should:
- First, look for a well-defined uptrend to begin with.
- Notice how the height of highs changes; each peak is lower, which indicates a loss of upward momentum.
- Identify the neckline, which is the line that supports. This is important for confirmation of the validity of the pattern when the price breaks below it.
How to Trade the Rounding Top Pattern
The key to trading the rounding top is waiting for confirmation of the trend reversal. Here’s how you can approach it:
Wait for the Break of Neckline:
The neckline also forms at the base, rounding top. When a breach in price happens in this level, it acts as a confirmation that such a pattern has formed fully and the downtrend probabilities are high.
Entry in Market:
You will go short once the price has broken the neckline, that is, confirmation of the start of the trend reversal.
Set Stop Loss:
Your stop loss should be set above the most recent high point of the rounding top pattern. This will protect you against an unexpected reversal in the market.
Set Profit Targets:
The target for the trade can also be estimated by calculating the height of the rounding top pattern itself from high to neckline and then reflecting that in a downward projection from the point of break of the neckline.
By proper setting of the target, a trade can give a very high-risk reward ratio. Many traders will not accept less than a 2:1 risk-reward ratio, meaning the potential reward must be at least sufficient to justify the risk being taken.
Pros and Cons of the Rounding Top Pattern
Pros:
- Easy to Identify in Live Market: Rounding top is relatively easy to recognize once one learns what signs to look for, namely gradual highs and a rounded shape.
- Occurs frequently across markets: it can be seen on all time frames and in all markets, meaning that it’s quite useful to traders.
- Precedes strong bearish trends: A rounding top is usually followed by a strong downward move once it is complete, hence an opportunity to short.
Cons:
- When markets are consolidating, or in sideways action, the rounding top on occasion will give false signals and not be tradable.
- Large Heights Can Be Costly: Rounding tops that form in longer time frames, such as in daily, weekly, and monthly charts, can be so big that it becomes prohibitively expensive to trade the pattern due to wider stops.
- Slow Execution: The rounding top is gradual, so this can sometimes take a longer time to get completely formed out, leading to some delayed execution on higher time frames.
Key Takeaways
Rounding Top as a Bearish Reversal:
The top has rounded off and is an uptrend reversal chart pattern that typically occurs at the end of a strong uptrend, after which the downtrend probably follows.
Formation Characteristics:
The formation resembles a smooth, rounded curve and can have more than one top (double or triple) before the reversal takes place.
Trade Entry:
Below the neckline, the price break can open the short position in the market. One can place a stop loss above the very high point of the pattern, whereas the profit targets should be determined using the height of this pattern.
Risk Management is Key:
While the rounding top can be an effective pattern, it’s not foolproof. Traders should always use sound risk management principles when trading.
Conclusion
The rounding top is a powerful pattern that can be used in spotting trend reversals, whether in the Forex market or outside its realm. It takes time to form, but the gradual nature provides a clearer signal to traders for entry at the start of the downtrend. Learn to identify the rounding top and understand the trading strategy that fits, and your trading toolkit will definitely become more productive.
If you want to delve a little deeper into the specifics of trading the rounding top pattern and refine your trading techniques, then our How to Trade Academy may be something you’d be interested in. Inside our trading room, you’ll get indepth tutorials and examples showing exactly how to put this pattern into action inside your strategy. Understanding how the rounding top pattern works will make you an even more confident trader in the Forex market.
