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

What is a rounding bottom pattern?

A rounding bottom is a chart pattern that signals a potential trend reversal. It appears during an existing downtrend and hints at a bullish reversal. The rounding bottom pattern can easily be recognized by its distinctive U-shaped curve. The pattern can be visible on various timeframes and can appear on the price chart of any trading instrument, ranging from forex to commodities and shares.

Is a rounding bottom bullish or bearish?

A rounding bottom pattern is exclusively a bullish chart pattern - the bearish variant is called a rounding top. A rounding bottom pattern shows us that the existing downtrend is losing momentum and that buyers are regaining the upper hand. A breakout above the resistance level confirms the rounding bottom pattern and paves the way for a recovery rally.

How to identify a rounding bottom

First, we are looking for an existing downtrend. As the downside momentum starts to weaken, a base (bottom) is formed, and the recovery phase begins. As the recovery continues, a U-shaped curve is formed.

It is important to note that with this pattern we will see a gradual rise of the price rather than a sharp reversal.

The resistance level represents the highest price level that was reached before the initial decline started. A breakout above this level will confirm the pattern and signal a bullish reversal.

The trading volume can provide traders with valuable insights about the validity of the pattern. Generally, we will see a decline in volume as the bottom is formed, and an increase in volume as the recovery commences.

Rounding bottom vs rounding top

A rounding top is a bearish reversal pattern that indicates the end of an uptrend and the beginning of a correction. A rounding bottom, on the other hand, is a bullish reversal pattern that hints at a downtrend ending, and the beginning 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 bottom chart pattern

The first step is to be able to identify a rounding bottom on the charts. There should be an existing downtrend present, followed by a distinctive U-shaped curve that marks the recovery, and finally, a breakout above the resistance line that confirms the actual pattern.

It is important to wait for the actual breakout above the resistance line, regardless of how tempting it might be to enter the trade early. The pattern is only confirmed once the breakout occurs.

Once the breakout has happened, traders will be looking to enter a long position, either by placing a market order or by having a limit order ready.

Typically, traders will place the stop-loss order below the base (bottom) of the pattern. However, if the distance is too great, the stop-loss order can be placed below a recent key support level that was formed during the rally from the base to the resistance line.

Where should the take-profit order be placed? A popular method is to take the distance between the base and the resistance line and project this upwards from the breakout point. For example, if the distance between the base and the resistance line is 200 pips, a trader would set his take-profit order 200 pips above the entry level.

Technical indicators can be used 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 bullish divergence.

Advantages of a rounding bottom

There are several advantages of trading a rounding bottom pattern, including.

1. A rounding top is always a bullish reversal pattern.
2. Its U-shaped form makes it fairly easy to spot.
3. The distance between the base and the resistance line makes setting the stop-loss and take-profit orders easier.
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 bottom

Despite the above, trading a rounding bottom can have some negative sides:

1. There could be a false breakout, as with any chart pattern.
2. The formation of the rounding bottom might take time, more so than with other chart patterns.
3. The pattern should be traded in a trending market, i.e., when an existing downtrend exists.

Conclusion

In brief, the rounding bottom pattern is a distinctive U-shaped chart pattern that signals a bullish reversal following a downtrend. It is characterized by a gradual decline to a trough, followed by a steady recovery and a breakout above a key resistance level. This pattern is versatile, appearing across various timeframes and trading instruments, and offers traders clear entry, stop-loss, and take-profit levels. While its gradual formation can test patience, patience, and proper risk management are key to effectively using this pattern.

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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.