What is a rounding top chart pattern and how to trade it?

What is a rounding top pattern?

A rounding top pattern is a chart pattern that indicates a potential trend reversal. It indicates that the existing uptrend is ending, and a bearish reversal is imminent. The rounding top pattern has a unique, dome-like shape and can appear on price charts of various trading instruments — from forex to commodities and stocks.

Is a rounding top bullish or bearish?

A rounding top pattern is strictly a bearish pattern — the bullish variant of this chart pattern is called a rounding bottom. A rounding top pattern indicates that the uptrend is losing momentum, meaning buyers are losing control and the market bias is turning bearish. A breakout below the support level (the base of the rounding top) confirms the bearish reversal and hints at a deeper correction.

How to identify a rounding top

A rounding top pattern has a characteristic shape and is relatively easy to spot.

First, we are looking for an existing uptrend. As the uptrend starts to lose momentum, price starts to retreat from the high to form a rounded curve.

This is the key difference between the rounding top and similar patterns such as the double top — we are not looking for a straight horizontal line, but rather a round shape. Instead of a sharp sell-off, the price starts to gradually decline after the peak has been reached.

Another characteristic is the trading volume. As the price moves towards the peak, the volume will typically decline but increase again once the sell-off has commenced.

There are two key levels to watch: The resistance level at the peak, which is the highest price level that has been reached during the formation of the pattern, and the support level located at the base of the rounding top. This support level is crucial as a breakout below will confirm the rounding top.

Rounding top vs. rounding bottom

A rounding top is a bearish reversal pattern that indicates the end of an uptrend and beginning of a correction. A rounding bottom, on the other hand, is a bullish reversal pattern that signals the end of a downtrend and the start of a recovery.

A rounding top has a dome-shaped curve, while a rounding bottom has a U-shaped curve.

When trading a rounding top, traders are looking to enter a short position once the price has breached the pattern’s support level. Trading a rounding bottom involves buying an asset once the price has breached the pattern´s resistance level.

How to trade a rounding top chart pattern

The first step of trading a rounding top is to be able to identify it on the charts. What we are looking for is an existing uptrend and a dome-shaped pattern that indicates a bearish reversal.

The peak is the highest price level of the rounding top. Instead of a sharp sell-off, we are looking for a gradual decline that shapes the distinctive curve. As the selling pressure increases, the price will start moving towards the support line at the base of the rounding top.

It is crucial to wait for a breakout below this level, as only then is the rounding top pattern confirmed.

Following a breakout below the support level, traders will be looking to enter a short position, either by placing a market order or by having a limit order ready.

A stop-loss order may be placed slightly above the peak of the rounding top, or above the most recent key resistance level formed during the decline. Placing the stop-loss order above the peak will give the trade more breathing room but may lead to an unfavourable risk-reward ratio.

The take-profit order is typically determined by measuring the height of the rounding top (peak-to-base) and projecting this to the downside. For example, if the distance from the peak to the base was 200 pips, the take-profit order would lie 200 pips south of the entry level.

As is the case with many chart patterns, traders can use technical indicators for additional confirmation. For example, indicators like the Relative Strength Index (RSI) can guide traders about overbought/oversold conditions or may be used as additional confirmation if there is a bearish divergence.

Advantages of a rounding top

Trading a rounding top pattern comes with some advantages for traders, which include:

1. A rounding top is exclusively a bearish reversal pattern.
2. It is fairly easy to identify due to its distinctive shape.
3. While this is not strictly a rule, the stop-loss and take-profit orders can easily be determined by using the distance between the peak and the base.
4. The pattern can appear on the price chart of any trading instrument.
5. The pattern can easily be combined with technical indicators for additional confirmation.

Disadvantages of a rounding top

There are also some downsides to trading a rounding top, which are:

1. As with any chart pattern, there is the chance of a false breakout.
2. The rounding top can be slow to form due to its shape. For example, the price might take considerable time to move towards the base.
3. A rounding top pattern should ideally be traded when markets are trending.

Conclusion

In conclusion, the rounding top is a distinctive chart pattern that signals a bearish trend reversal — that is, marking the end of an uptrend and the start of a potential correction. While its ease of identification and compatibility with technical indicators are notable advantages, traders should be cautious of false breakouts and the pattern's slow formation. By combining the rounding top with sound risk management and additional confirmations, traders can effectively use this chart pattern to their advantage.

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This information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. It has been prepared without taking your objectives, financial situation and needs into account. Any references to past performance and forecasts are not reliable indicators of future results. Axi makes no representation and assumes no liability with regard to the accuracy and completeness of the content in this publication. Readers should seek their own advice.