Round top pattern offers a potential glimpse into bearish trend reversals. This U-shaped price movement, following an uptrend, suggests the market might be shifting toward a downtrend.
By recognizing this chart pattern, traders can anticipate a potential decline and position themselves for short trades, potentially capitalizing on falling prices. This guide will discuss how traders can trade the rounding top chart pattern.
What is a rounding top pattern?
Rounding top patterns is a bearish reversal chart pattern that signals a potential shift from an uptrend to a downtrend. A breakout below the neckline signals a potential reversal but is not a confirmed signal.
Traders should look for confirmation factors such as –
- Volume: A significant increase in volume on the breakout below the neckline suggests more participation from bears, supporting the price decline
- Other technical indicators: Consider additional indicators like moving averages. After the breakout, look for a shorter-term moving average crossing below a longer-term one. This indicates a potential shift in momentum to the downside
On the contrary, a rounding bottom pattern is a technical indicator that suggests a potential upward trend reversal following a downtrend. The rounding bottom chart pattern suggests that exit pressure is weakening and entry pressure is increasing.
How to identify a rounding top chart pattern?
Here's how to identify a rounding top pattern in forex technical analysis:
- Uptrend: Look for a sustained upward movement in the forex pair one is interested in. This will be characterized by a series of higher highs and higher lows.
- Price stalling and rounding: Identify a gradual slowing of the uptrend. The price starts to make lower highs as momentum weakens, forming a rounded top shape on the chart. This could take weeks or months to develop.
- Neckline: Draw a horizontal line connecting the two lowest points of the uptrend before the top formation. This line represents the neckline, a support level.
- Breakout: If exit pressure intensifies depending on the market conditions, the price eventually breaks below the neckline. This breakout suggests a potential reversal from uptrend to downtrend, confirming a rounded top chart pattern
How to identify bearish signals with a rounded top pattern?
Spotting bearish signals in forex involves identifying a potential trend reversal. The rounding top pattern starts with a clear uptrend, but as the price momentum weakens, the highs become progressively lower, forming a rounded top shape. This signals a possible exhaustion of entry pressure.
A crucial level to watch with the rounded top pattern is the neckline. If exit pressure intensifies, the price eventually breaks below the neckline. By combining the rounding top chart pattern formation, a confirmed breakout with increased volume, and additional technical confirmations, traders can gain confidence in identifying potential downtrends or bearish signals in the forex market.
How to trade with a rounding top pattern?
Identify the rounding top
Look for a clear uptrend in the price chart patterns, consisting of a series of higher highs and higher lows.
Confirm lower highs
Then, identify a gradual slowing of the uptrend. As momentum weakens, the price starts making lower highs, forming a rounded top shape on the chart. While not every rounding top pattern will have perfectly defined lower highs, a gradual decrease in the highs compared to the established uptrend is a key sign of weakening momentum.
Analyze trading volume
Pay close attention to volume throughout the formation of the rounding top. Ideally, the volume should decrease as the price forms the rounded top, suggesting a decline in entry pressure.
Draw the neckline
Draw a horizontal line connecting the two lowest points of the uptrend before the top formation. This line represents the neckline, a support level.
Breakout and confirmation
Wait for the price to break below the neckline. This is a potential bearish signal. Look for an increase in trading volume on the breakout point below the neckline. This suggests more bears are participating, pushing the price down.
Confirm with moving averages (MA)
For added confirmation, look for a shorter-term MA in the chart pattern crossing below a longer-term one after the breakout. This indicates a potential shift in momentum to the downside.
Identify support levels
Identify potential support levels below the neckline where the price might find temporary entry interest. This can help traders determine potential take-profit or stop-loss levels.
Enter the trade
Once the trader confirms the breakout and the supporting technical indicators, they can consider entering a short position in anticipation of the price continuing to decline.
Advantages and risks of a rounding top pattern in a bearish market
Advantages
- Gradual recognition: Unlike sudden trend reversals, the rounding top pattern develops gradually. This allows traders to identify a potential downtrend as it forms, potentially giving them more time to prepare and enter short positions
- Defined support levels: The neckline, formed by connecting the two lowest points before the top, acts as a defined support level. A break below this level signifies a potential trend reversal into a downtrend, offering traders a clear entry point for short positions
- Clear reversal signals: With confirmation from increased volume and other technical indicators, a breakout below the neckline provides a strong visual and technical signal of a potential downtrend. This can boost trader confidence in entering short positions
Risks
- Market condition dependency: While the rounding top suggests a downtrend, it is not foolproof. In a strong overall bearish market, the pattern might be less reliable. To strengthen the signal, it is crucial to consider the broader market sentiment
- Choppy market behavior: Choppy markets with frequent price swings make it difficult to identify a clear rounding top formation. The rounding top formation itself can lead to further choppy price action as the price tests the support level (before the breakout) multiple times. This can make it challenging to pinpoint the exact entry point for a short position
- Lack of confirmation: A breakout below the neckline alone isn't a guaranteed reversal signal. False breakouts can occur, leading to losses if traders enter short positions prematurely. Confirmation through increased volume, moving average crossovers, and overbought readings on oscillators helps mitigate this risk
Place short trades with a rounding top pattern
The rounding top pattern in forex is a double-edged sword. It signals a potential downtrend, enabling traders to short for potential gain. However, caution is needed since false breakouts below the neckline and unreliable signals in strong trends or volatile markets can lead to losses. Traders should set up a thorough risk management strategy when trading the technical pattern. Confirmation through other indicators and a clear view of the broader market context are essential before acting on the rounding top's bearish signals.
Disclaimer:
- All material published on our website is intended for informational purposes only and should not be considered personal advice or recommendation. As margin FX/CFDs are highly leveraged products, your gains and losses are magnified, and you could lose substantially more than your initial deposit. Investing in margin FX/CFDs does not give you any entitlements or rights to the underlying assets (e.g. the right to receive dividend payments). CFDs carry a high risk of investment loss.
