Rounded Top Stock Chart Pattern

Rounded Top Stock Chart Pattern

Rounded Top Chart Pattern

Implication

A Rounded Top is considered a bearish signal, indicating a possible reversal of the current uptrend to a new downtrend.

Description

A Rounded Top is dome-shaped, and is sometimes referred to as an inverted bowl or a saucer top. The pattern is confirmed when the price breaks down below its moving average.

Important Characteristics

Following are important characteristic to look for in a Rounded Top.

Shape

Robert D. Edwards and John Magee describe the rounded top as being a "gradual, progressive, and fairly symmetrical change in the trend direction, produced by a gradual shift in the balance between buying and selling". For a rounded top, the price can fluctuate or be linear. However, the overall curve should be smooth and regular, without obvious spikes.

Volume

Volume can fluctuate, however volume generally appears to be concave, and follows the inverse of the price pattern. Therefore, as the price begins to ascend, volume tends to decrease. Once the top of the price pattern starts its downward turn, volume tends to increase.

As Martin J. Pring writes in his book, Technical Analysis Explained, "The tip-off to the bearish implication of the rounded top is the fact that volume shrinks as prices reach their highest levels and then expand as they fall."

Duration of the Rounded Top

Rounded Tops typically occur over a period of about 3 weeks, but can also be observed over several years.

Trading Considerations

Duration of the Pattern

The duration of the pattern indicates the significance of the price movement. Clifford Pistolese writes, "a rounding top that is completed in a couple of months will usually be less significant than one that takes a much longer time to complete."

Target Price

After a downside breakout, technical analysts may use the starting price at the left side of the dome to determine where the price may head. However, you will want to monitor the stock with interest. Price may end higher than it was at the beginning of the pattern. Furthermore, there is the potential for the price to rise after the rounded top completes. Thomas N. Bulkowski writes that, "most of the time prices rise after a rounding top completes".

Criteria that Supports

Volume

Volume should diminish as the pattern forms.

Moving Average

Moving averages help to determine whether the rounded top has the potential to descend. For a rounded top, the price should cross below the moving average when it begins to descend. When this crossover occurs, the pattern is "confirmed".

There is an abundance of literature about moving averages if you are interested in understanding how they operate. In simple terms, the moving average can be used to detect a possible pattern success or failure. Typically, a moving average represents the closing price of a stock over a set number of days, and can be used to anticipate the general direction of a stock. Depending on the type of stock, investors may decide to use a long, medium or short term moving average. For example, short duration patterns generally use a 50-day moving average, and longer patterns generally use a 200-day moving average.

Trendlines

Price trendlines provide investors with a way to monitor and validate a rounded top. To track a potential rounded top, technical analysts draw a line just beneath the lower limits of the price uptrend. The trendline is straight, regardless of the fluctuations of the price. When the price drops beneath the line, there is indication that the uptrend has ended.

When the downtrend begins, technical analysts draw another line just above the upper limits of the price pattern, and continue down towards the start price of the pattern formation. When the price rises above the line, there is an indication that the new downtrend has ended.

Criteria that Refutes

Upside Breakouts

A promising-looking rounded shape with an breakout above the moving average, instead of below, may not establish or maintain a new downtrend.

Underlying Behavior

A Rounded Top forms as investor sentiment shifts gradually from bullishness to bearishness. As the sentiment turns up toward the top, there is a drop off in trading volume due to the indecisiveness in the market. There is a period of consolidation at the top as trading bounces within a certain range, then finally there is a gradual downturn marking the shift to bearishness. As investors become more decisive about the bearishness, there is an increase in trading volume.