The rounding top pattern is a common reversal indicator where traders consider it as marking the end of an uptrend and the beginning of a potential downtrend.
Like the head and shoulders pattern, the rounding top features a slower and more gradual shift in momentum, which makes it such an asset to use for understanding trend reversals. This is your step-by-step guide on how to identify and trade with the rounding top pattern.
Identifying the Rounding Top Pattern
The rounding top pattern is not that obvious as most of other chart patterns and may be pretty tricky to recognize. However, the formation of it is extremely crucial for trading:
First Uptrend: Prior to finding the rounding top, locate a confirmed bullish trend in the market first.
Rounded Top Formation: A series of highs are seen that gradually lose their strength to form a rounded, almost parabolic shape. That would mean market sentiment shifts gradually.
Failed Head and Shoulders: Many of these rounding tops come with patterns resembling the head and shoulders style in their formative stages without fully realizing their structures and hence differentiate the two here.
Neckline: Draw a trend line connecting the low points within the pattern—the neckline. This is the key support line.
How to Trade the Rounding Top Pattern
Trading the rounding top pattern involves the following:
Step 1: Confirm the Uptrend
The market should be in a strong bullish trend before the formation of the rounding top.
Step 2: Identify the Formation
For that, look for a gradual, rounded top structure where the series of high points gets progressively lower, telling you that the momentum’s been shifted.
Step 3: Neckline Break
Wait until the rounding top has its price broken by falling below the neckline. Breakage from underneath your rounding top is a short.
Step 4: Set Stop Loss
Place a stop-loss just above the highest point of that rounding top formation or slightly beyond the recent peak as their limit of potential loss.
Step 5: Setting the Profit Targets
Calculate your profit target by measuring the height of the rounding top from its peak to the neckline and then project this distance downward from the neckline.
Example Trade
If you identified a rounding top pattern with a clear neckline, then you’ll sell short when the price breaks down through that neckline. Your stop loss is above the high of the pattern and your profit target will depend on the size of the pattern. Sometimes this results in an incredible risk-reward ratio, which has been observed in many winning trades.
Advantages of the Rounding Top Pattern
Advantages
- Visible: The rounding top pattern is easy to spot in live markets.
- Frequent: This pattern occurs very frequently in all markets and time frames, and thus it is accessible for traders.
- Forecasts Strong Bearish Trends: The rounding top usually appears before major downtrends, once confirmed.
Disadvantages
- False Breakouts: The pattern can give false breakouts, especially in consolidating markets.
- Large Height: The extended nature of the rounding top can make it expensive to trade, especially on longer time frames, such as daily, weekly, or monthly charts.
- Execution Time: Rounding top formations do take some time, which of course, is even more patience when in longer time frames.
Key Takeaways
Reversal Indicator: Rounding top is a bearish reversal pattern in strong uptrend.
Visual Structure: The pattern typically takes the shape of an inverted parabola, with a succession of lower highs.
Entry Point: Go short when price breaks below the neckline.
Stop Loss: The stop loss should go above the formation’s high.
Profit Target: Set the target based on the pattern’s height, measured from the peak to the neckline.
Risk Management: The rounding top pattern is not perfect. Therefore, always use proper risk management when trading.
Conclusion
The rounding top is one of those powerful trading formations in trying to identify and trade in a trend reversal. While sometimes not so obvious to determine every time, its potential of selling signals given for major downtrends will be worth mastering. For more information on rounding top, trade using in-depth tutorials with practice materials available at trading education sites.
