Rounded Top Pattern in Trading: Meaning and Factors

In our previous chapters, we covered in depth different chart patterns like head and shoulders, double top and bottom and more. All these patterns had distinct characteristics and were studied to identify market trends and reversals. 

In the same context, we explore the rounded top pattern in this chapter. You will also appreciate the differences between this pattern and other bearish reversal patterns as we progress. 

Let’s start by first understanding what the rounded top pattern is. 

What Is the Rounded Top Pattern?

The rounded top pattern is one of many chart patterns that signal a potential trend reversal from bullish to bearish. It is formed when, after an uptrend, the security price slows and starts to slide downwards while ‘rounding off’ at the top. 

This gives the pattern the appearance of a dome, a rounded hill, or an inverted ‘U.’ 

Take a look at the image below –

Rounded-top patterns are especially popular in technical analysis and are used by traders to identify trend reversals. The pattern is indicative of a shift in market dynamics as buying pressure exhausts and selling pressure starts to build in. 

Rounded top patterns may take several weeks to months to form, depending on the market situation and volatility. 

Now, let’s study this pattern in more detail 

• Formation of the Rounded Top Pattern:

The rounded top pattern is formed when an uptrend loses momentum and transitions into a consolidation phase. As the buying pressure diminishes, the price gradually forms a series of lower highs, creating a curved or rounded shaped pattern resembling an inverted ‘U.’ As the pattern indicates a shift in market sentiment from bullish to bearish, traders may use it for shorting security, i.e. betting on a security’s price fall. 

You can visualise a rounded top pattern as an upward price movement of security that reaches a peak and then starts to decline to form a gradual downward curve. Note that the rounded top pattern is characterised by smooth and gradual crue rather than sharp and sudden price drops, distinguishing it from other bearish reversal patterns. 

• Formation of Neckline/Support Levels and Resistance:

The support/neckline in this pattern is formed by connecting the successive lows during the consolidation phase. The support level is a crucial parameter in confirming the pattern and helps traders identify the breakout point. A decisive break below the support/neckline confirms the rounded top pattern and signals a shift in market sentiment (from bullish to bearish). 

The highest peak point in the pattern is where the resistance level is drawn. This may indicate failing buying pressure or a point where the price of the security struggles to move above and beyond. The point is used to measure the height of the pattern from the neckline and to calculate the target price. 

• Volume and Target Price:

As mentioned in previous chapters, volume is an extremely important parameter concerning chart patterns. Increasing selling volume during the breakdown below the support/neckline should strengthen the pattern’s bearish bias. Also, the volume may be lowest at the centre of the pattern and highest around the reversal point. Traders must pay attention to volume trends as they can indicate and validate the strength or weakness of the potential trend reversal. 

Now, the target price can be determined by measuring the distance between the peak and the neckline and then projecting it downward from the breakout point. We’ll cover this in detail below. 

How to Trade and Identify a Rounded Top Pattern?

Based on what we discussed above, to identify this pattern, you may need to first study the monthly or weekly stock of the security you wish to trade in. Look for an uptrend with waning buying pressure leading to a series of lower highs. It may start to appear like an inverted ‘U’ Once you identify the pattern, you can connect the left and right rims to form the support level or neckline

Now that you have a pattern and neckline in place, placing a stop loss should be a priority to manage risk. A common approach is to set the stop loss slightly above the neckline or breakdown point in case the market moves against you. You should also observe how quickly the trend reversal is happening. For instance, if the downward movement is sharp, a short position may make large profits, but if the trend is taking place slowly or moving sideways, it can cast a shadow on the trend’s strength. 

Once stop loss is established, you can calculate a target price. As mentioned above, calculating the target price for the rounded top pattern involves measuring the distance from the support/neckline to the pattern's peak and projecting it downward from the breakdown point. This projected distance can provide an estimate of the magnitude of the decline. Traders may also consider other technical factors, such as Fibonacci retracements, key support levels, or previous swing lows, to determine additional target levels.

Let's consider an example of a rounded top pattern on a stock. If the distance from the support/neckline to the peak is ₹10, the projected target price would be ₹10 below the breakdown point. So, if the breakdown occurs at ₹150, the target price would be ₹140 tentatively.

Do note that trading the rounded top pattern requires confirmation through price action, volume analysis, and consideration of other technical indicators. You should also monitor market conditions and adjust trading strategies accordingly.

Factors To Consider When Trading Rounded Top Pattern

Now that you understand the rounded top pattern better, let’s study some factors to consider when trading this pattern. 

1. Time Frame: As mentioned above, the timeframe is critical to understand the validity of the trend and how it may eventually pan out. In shorter time periods, the trend may not emerge strongly and sometimes may even be a false signal. On the contrary, a longer time period can allow the trend to fully emerge and decrease the possibility of false signals. 
2. Volume: Increasing volume post-breakout point should reinforce the bearish signal, indicating strong selling pressure. Also, ideally, volume should be the lowest at the pattern's centre. But remember this: sometimes the volume may not spike after the neckline break. However, this must not be considered a pattern failure.  Consider all other technical factors before making a trading decision. 
3. Pattern Confirmation: An important but often overlooked factor is pattern confirmation. Sometimes, traders do not read the patterns correctly and indulge in over or under-trading. To avoid this, especially when trading rounded top patterns, ensure that the pattern is confirmed. Traders must look for a clear break below the support level/neckline with an increase in selling volume to validate the pattern.  

Lastly, remember that markets are dynamic, and no chart pattern is foolproof. A sudden change in market conditions due to any reason can render the pattern meaningless. Ensure you have accounted for all fundamental and technical factors before trading the rounded top pattern. Moreover, employ adequate risk measures to protect your capital.

And with this, we have reached the end of the chapter on the rounded top pattern. In our next chapter, stay tuned as we explore the opposite concept of the rounded top pattern, which is the rounded bottom pattern.