barg.gif (3312 bytes)

Home > Education > Technical Analysis > Chart Patterns > Reversal > Rounding Top

Chart Patterns - Reversal - Rounding Top

Technically speaking, a rounding top is a rally to a new high on strong volume, several weeks of light trade with limited upside progress, several more weeks of light trade with a decided downward bias, followed by a sharp move lower on strong volume.

Why Does It Happen?

At first and maybe even second glance, rounding top patterns are going to look very familiar.  This is because they have many of the same characteristics of head and shoulders top patterns.  Often there will be a very clear "head", that is a rally to a new high in the middle of the pattern.  Rounding top patterns differ from garden variety head and shoulders top patterns in that very often there are multiple "shoulders".  So, why does this happen?  As you might expect, rounding top patterns occur for many of the same reasons as do head and shoulders top patterns.  The first part of the pattern will always take shape after an extended rally to new highs.  The flow of fundamental news is usually positive and buyers seem willing to pay increasingly higher prices -- for a while.  Following one positive development the stock rallies to a fresh new high on strong volume but to the surprise of bullish investors, sellers are more than willing to liquidate positions.  After a few sessions, the stock begins to move lower on increased volume.  Investors and analysts will normally rationalize this development as simple profit taking but the rise in volume and weak price action is a clue, longer-term investors that bought at lower prices are selling, they are using good news to distribute stock.  The rally to new highs and pullback to a nearby support level (reaction low) completes the first phase of the pattern.   Because the fundamental news remains positive, bullish investors soon return, sending the stock back to test the recent high but once again they are turned back by sellers and the stock drifts back to the reaction low (now key support).  Roused by more positive commentary by either the company or Wall Street analysts buyers make another run at what has become overhead resistance and to their delight, the stock pushes to a new high.  There is just one problem, volume is even more feeble than the previous two rallies and the move higher stalls.  Buyers are beginning to grow anxious because the fundamental news is positive and sentiment excellent yet sellers continue to exert downside price pressure.  A new decline begins but the weakness ends as the stock approaches key support.  Against the backdrop of more good news on the fundamental front, buyers make two further attempts to push the stock through resistance.  During each attempt volume slows progressively and ultimately the stock slumps back to support.  At this point buyers have reached their limit, they begin to question everything -- yes, the fundamental data is currently strong but will that last?  Five rallies have failed.  It is at this point of weakness that the first piece of bad news is released.  Suddenly all of the assumptions that lead the stock to new highs are called into question, those that had been supporting the stock panic and key support fails miserably.  The stock gaps lower and a huge decline begins.  Weeks later the stock trades back to longer-term support.

How are Technical Measures and Targets Derived?

Unlike head and shoulders top patterns, rounding tops generally do not lend well to price targets because the pattern is meandering.  In most cases one can expect a decline back to the longer-term support level following a break below key support.

The Rounding Top For International Business Machines

In a world of earnings warnings and unfulfilled promises in the winter of 2001, International Business Machines (IBM) was a refreshing success story.  Not only had the firm succeeded where others had failed but by all accounts, it was building market share and becoming the undisputed leader of the new economy.  One year after introducing is very successful line of Shark data storage servers they began rolling out software applications for mission critical UNIX and LINUX platforms.  The stock moved from a low of $87.50 on March 21 to a high of $99.89 on April 16 before releasing first quarter earnings on April 18.  The earnings were in-line with Wall Street expectations. The revenue numbers were well ahead and the stock spiked higher, trading to $115.87 the next session and as high as $118.93 by May 2.  Wall Street analysts were falling over one another to recommend the stock, IBM was seen as the savior for the market.  But just two days after all of the positive talk the stock settled back to $111.18.  Just two days later the stock was moving higher again on a note from UBS Warburg suggesting that IBM would "leapfrog" the competition with its UNIX servers.  Once again the stock traded back to $118.93 only to decline back to $111 by May 14.  Once again Wall Street firms defended the stock and IBM pushed to a new high on May 21 at $119.88 following news releases for several new products and contract wins. The next day IBM CEO Lou Gerstner filed to sell 250,000 shares and the stock began to move lower again, testing $111 by June 1.  The next session IBM announced a software and hardware deal with the Chinese government.  The stock rallied to back to $118.93 over the next two sessions but by June 26 shares were back at $111.  The final rally came June 29 when IBM announced it had built the "worlds fastest transitory".  After an initial move to $116.87 IBM shares once again slumped to $111.  On July 6 IBM competitor EMC Corp. (EMC) announced its third earnings warning in as many quarters and IBM shares gapped though support at $111 at the open. A downside breakout became effective, IBM shares traded to $92 just two months later.

Vital Signs

back to original

Members   Advisory Services   Editorial   Education   Tools   Contact Us   Help   Advertise   Privacy Statement   Legal Notices