Most traders use technical analysis to find short-term opportunities in hourly or daily charts, but some indicators and patterns are designed to work on weekly or monthly timeframes.
Investors use these forms of technical analysis to identify long-term trends, while short-term traders can use them for insights into the bigger picture. For example, a short-term trader may only place short-term trades in the direction of the long-term trend.
In this article, we will look at how to identify and use rounded tops and bottoms, as well as explore some real-life examples of the pattern in action.
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What Is the Rounded Top & Bottom?
The rounded top is a long-term bearish reversal pattern that signals the end of an uptrend and the possible start of a downtrend. Conversely, the rounded bottom is a long-term bullish reversal pattern that signals the end of a downtrend and the possible start of an uptrend. Unlike sharp V-like price movements, rounded tops and bottoms have a U-like appearance and occur over the course of several weeks or months.
There are five stages to rounded top and bottoms:
- Previous Trend: Reversal patterns require a previous trend to reverse, and rounded tops and bottoms are no different. Rounded tops should be preceded by an uptrend and rounded bottoms should be preceded by a downtrend.
- First Leg: The first leg of rounded tops and bottoms are a continuation of the previous trend toward a tipping point. If the move occurs very rapidly, the pattern should be classified as a single, double or triple top or bottom.
- Tipping Point: The tipping point can be more V-like than U-like, but it shouldn’t be too sharp and should take several weeks to form.
- Second Leg: The second leg higher or lower from the tipping point should occur over roughly the same amount of time as the first leg.
- Breakout or Breakdown: The rounded top or bottom pattern is confirmed when the price breaks above or below the neckline of the pattern. As with other breakouts, this level becomes a key support or resistance level moving forward.
Rounded tops and bottoms perform best with U-shaped volume, where volume falls as the pattern reaches a tipping point and accelerates as the reversal picks up steam.
Trading Rounded Tops & Bottoms
Traders use rounded tops and bottoms in the same way as many other longer-term reversal patterns, such as the head and shoulders pattern.
Buy (or sell) signals occur when the price breaks out from the neckline. For example, a trader might initiate a long position after the price breaks out from the neckline of a rounded bottom or initiate a short position after the price breaks down from the neckline of a rounded top.
Stop-loss points are typically placed below the neckline of the rounded bottom pattern or above the neckline of a rounded top pattern. If there’s a sustained move below the neckline, the pattern is invalidated and it’s a good idea to exit the position at a small loss.
Take-profit points are calculated by measuring the distance between the top or bottom of the pattern and neckline, and then applying that distance to the neckline in the other direction. In some cases, traders may lock in profits on the way up or down using Fibonacci extensions from the neckline or other technical indicators.
Learn more about the different day trading rules that apply to U.S. investors here.
Examples of Rounded Tops & Bottoms
Let’s take a look at an example of a rounded top pattern in the AUD/CAD currency pair:
In this example, the AUD/CAD produced a rounded top over the course of a week or two. The neckline was formed by connecting a prior high with trend line support that formed near the bottom of the rounded top pattern. Stop-loss points could have been placed just above the neckline, while the take-profit point was calculated by computing the distance between the neckline and rounded top (~789 pips) and subtracting that number from the neckline price.
The pattern accurately predicted both the breakdown and the extent of the following decline. In addition, the neckline served as a future area of key resistance where a double-top formed in early-to-mid December.
The Bottom Line
Rounded tops and bottoms are long-term reversal patterns that can both help investors identify long-term trends and active traders see the bigger picture.