2-month lookback period
L22%, C51%, H56%
L20%, C21%, H19%
464
Rectangle Tops
Sample Trade
465
of it especially if you are losing money. Often, prices will return to the formation boundary then turn away. If you do not get out during the pullback orthrowback, then it is likely your losses will grow. Do not pass up the secondchance and do not hope that prices will continue recovering. They will not!Before placing a trade in a rectangle formation, see if the chart pattern ispart of a larger pattern. Sometimes, the rectangle is the horizontal part, called
the corrective phase, of a measured move up formation. Knowing that a rectangle is a subpart of a measured move allows you to get a better gauge on theexpected price move. When the rectangle top is a reversal of the prevailingprice trend, the resulting formation resembles a flat top. Suspect that a reversal might be under way if the price trend leading up to the rectangle is unusually steep.
Sample TradeFeb 95
Figure 33.6 Rectangle top with breakaway gap and exhaustion gap. Dave tradedthis formation after buying it once the throwback completed.
Dave is an artist. It is tough making a living and he wants to move to the computer world and become a graphics artist. He has been playing around withsome hardware and software that duplicate the feel of a brush on various textures but wants to get the latest versions.Recognizing chart patterns comes easily to him. With his keen eye, he has
breakouts. When using my computer, the technique comes close to the ultimate high. On paper, the results are less accurate. I have not tested this methodextensively and cannot vouch for its accuracy. However, one has to wonderhow measuring a formation (in inches) can accurately translate into a pricemove, but who knows, the system might work or at least prove helpful.Returning to Table 3 3.5, the breakout direction is usually in the directionof the prior trend. For Figure 33.6 the direction is upward and that is thedirection in which the breakout occurs. Once prices close outside a formation,then a breakout (or premature breakout) occurs. If the breakout is upward, golong or cover your short. If the breakout is downward, then short the stock orsell your position. If the rectangle is tall enough and providing you discover itquickly enough, you can trade the formation as it swings from trendline totrendline. Short or sell at the top trendline and cover or buy at die bottomtrendline. Keep an eye on the price trend leading to the formation in case a
been on the prowl for a lucrative stock play. That is one reason he stumbledacross the rectangle shown in Figure 33.6, but he did not spot the rectangle ina timely fashion. The only reason he noticed it is because of the throwback.Throwbacks and pullbacks are peculiar enough with their hooking retrace that
they are easy to spot. One has only to look back and identify the associated formation.Dave computed the formation height and applied it to the top of the rectangle to get the expected minimum price move. Did he pull the trigger whenprices threw back to the formation? No, he waited. He followed the stockclosely and when it gapped up (a breakaway gap), he bought and received a fillat 40. Each day the stock moved higher and in 3 days it had reached the target
price of 433/4. The next day the stock gapped again (exhaustion gap) signalingan impending end to the rise. The next day prices faltered, and that is when he
sold and closed out his position at 47'/2. He netted over $7 a share or 18% in
breakout occurs. If the stock moves outside the rectangle trendline and you are
less than a week.
losing money, close out your position. You might also want to get on the bandwagon and trade in the direction of the new trend.If the breakout turns into a premature breakout when prices return to therectangle proper, do not panic. There is still a chance that prices will resume
He took half his profits out of the market and upgraded his tools. Withthe remainder, he kept trolling the markets looking for another opportunity.
their original breakout direction. Again, if the trade goes against you by shooting out the other side of the rectangle, then close out your position and do itquickly. If you hesitate, you may have another opportunity to add to your position or close it out if the formation pulls back or throws back. Take advantage
Tour
34Rounding Bottoms
467
only (a breakout being when prices move above the left saucer lip), then thefailure rate drops to just 5%. I consider failure rates above 20% to be alarming.The chart pattern sports a 54% average gain with a likely rise of 20%. Almosta quarter of the formations have gains over 90% and that pulls the averageupward. The large gain masks the performance of the most likely rise. With adeep cup formed over many months, it makes sense that the measure rule
would have trouble predicting accurate price targets. Prices fulfill the measurerule just 36% of the time for successful formations with upside breakouts.
TourFigure 34.1 shows an example of a rounding bottom on a daily scale. I wouldnot call it a good example because the bottom is too irregular. In mid-May
there is an out-of-pattern downward price decline that ends with prices quicklyrebounding. In late June prices jump up then fade back down. The June rise isnot uncommon so do not get too excited when it happens in a stock you own.
Prices should return to near the base of the rounding bottom before continuRESULTS SNAPSHOT
ing to rise. The volume trend takes on the appearance of being rounded if youignore the four annoying spikes in the center.
Appearance
A long, rounded upward turn in prices
Reversal or consolidation
Long-term (over 6 months) consolidation
A rounding bottom marks a struggle between buying demand and sellingpressure that is nearly equal. Through the first part of the formation, the
Failure rate
38%
Failure rate if waitedfor upside breakout
5%
Average rise
54%, with most likely rise being 20%
Percentage meetingpredicted price target
36%
Synonyms
Rounding Turns, Saucers
See also
Bump-and-Run Reversal Bottom; Cup with Handle;Head-and-Shoulders Bottom, Complex; Scallops,Ascending and Descending
Rounding bottoms, rounding turns, and saucers are synonyms for the sameformation. The pattern differs from the cup-with-handle and scallop formations in subtle ways, so be sure to study those formations if you are unsureabout identification.If you consider that this formation acts as a consolidation of the prevailing trend and anything acting contrary to that is a failure, then the failure ratefor this pattern is very high at 3 8%. However, if you consider upside breakouts466
Canandaigua Brands Inc. A (Beverage (Alcoholic), NASDAQ, CBRNA)
Jan 94
Feb
Mar
Apr
May
Jun
ul
Aug
Sep
Oct
Nov
Figure 34.1 A rounding bottom on a daily scale. The bottom takes a brief dip inmid-May and a quick rise in late June.
468
Focus on Failures
Rounding Bottoms
469
sellers have the upper hand as they drive prices lower. Eventually, the forcescome into balance and the stock bottoms out and moves horizontally. Laterstill, buying demand picks up and the stock inches upward. The climb is notalways a smooth one. Sometimes, a large upward demand spike occurs sending the price skyrocketing, but in a month or so prices head back down andplane out slightly above where they left off. Then they resume their climb.When the stock reaches the old high, selling pressure usually drives priceslower, forming a handle. Prices recover and break through the old high andpush higher still.
Identification GuidelinesAs chart patterns go, rounding bottoms are easy to identify. Table 34.1 listsguidelines for their identification. Since rounding bottoms are often quite long(in this study, the longest is over 2l/i years), I usually use the weekly scale tomake identification easy. I search for a price pattern that looks like a bowl orsaucer. Once I discover the pattern, a quick glance backward finds prices trend-
ing upward for quite a while. The rounding bottom is usually a gentle retraceof some of the gains.Consider Figure 34.2. The most recent up leg of the climb to the formation begins in late December 1991 on very high volume. Prices climb from aweekly low of about 4 to a high of 95/ie, a gain of 235% in about 3 months.Then the stock eases over. Prices move lower and retrace much of their gains.The decline is not a quick straight-down affair. Rather, the stock moves loweron its way to 4% by curving around and flattening out.Once prices reach the low, they move hesitantly higher by traveling horizontally for several weeks before beginning an accelerated climb. Prices reachthe level of the left saucer lip and do not pause. They keep climbing until theyreach 13 and then 16 before backing down to 11.
Table 34.1Identification Characteristics of Rounding BottomsCharacteristic
Discussion
Weekly scale
I use the weekly scale to identify these behemoths, althoughyou can use the daily scale if you wish.
Rounded bowl shape
The price trend curves gently usually over many months andusually after an upward price trend. Connect the weekly lowprices to visually construct a saucer or bowl shape in yourmind.
Curving volume trend
The volume trend sometimes mimics the price trend byappearing as a bowl.
91
A S
O N D 9 2
F M A M |
|
A
S
O
N
D
9
3
F
M
A
M
|
J
A
S
O
Figure 34.2 This is a good example of a rounding bottom on the weekly scale.Notice the bowl-shaped volume trend.
A rounding bottom does not require a handle, which is a price consolidation area that commonly forms immediately after the right saucer lip, but mosttimes you will see one. After reaching the lip of the saucer, prices usually dropand consolidate before heading higher. A handle is typical behavior whenprices reach an old high. The rise falters as tepid demand or excessive sellingpush prices lower; then, the two highs act as a resistance zone. Sometimes,prices make several attempts before pushing through the resistance and moving higher; sometimes, prices just give up and roll back downhill.
The volume trend usually echoes the price trend by rounding upward too.You can see this in Figure 34.2 although it is not as pronounced as it sometimes is.
Focus on FailuresTo be fair, the preponderance of failures are probably due to semantics. Whenstudying this formation, I discovered that most act as consolidations of the prevailing trend. After moving upward, prices round down, swing around, andhead back up. I label those chart formations that do not fit this template as failures. Figure 34.3 shows an example of such a failure; it acts as a reversal of theprimary trend. Prices trend down beginning on the left side of the chart to thebase of the rounding bottom. Then, prices swing around and begin a newtrend upward.
470
Rounding Bottoms
Statistics
471
Table 34.2General Statistics for Rounding Bottoms
American Home Products (Drug, NYSE, AHP)
Description
Statistic
Number of formations in 500 stocks from 1991
to 1996
,M|
| A S O N D 9 3 F M A M |
| A S O N D94F M A M J |
A S O N D95 F M
Figure 34.3 Rounding bottom that acts as a reversal of the trend.
The formation is a founding bottom, but it does not act like a consolidation. If you had shorted this formation with the expectation that prices would
243
Reversal or consolidation
163 consolidations, 80 reversals
Failure rate
93 or 38%
Failure rate if waited for upside breakouts
11 or 5%
Average rise of successful formations
54%
Most likely rise
20%
Of those succeeding, number meeting or exceedingprice target (measure rule)
50 or 36%
Average formation length
8.5 months (259 days)
Obviously, the statistic suggests a trading tactic: Wait for prices to climb abovethe right saucer lip before buying the stock (watch out for handles too; buyafter the handle forms and prices move up).
The average rise of successful formations is 54% compared with a usualgain of 40% in other bullish chart patterns. However, the most likely rise is20%. Figure 34.4 shows a frequency distribution of gains for successful round-
continue down, you probably would have wound up with a loss. Thus, I consider this formation and others like it as failures.
Another type of failure, called a 5% failure, is when prices move in theintended direction after the formation completes but fail to travel more than5% before turning around and heading substantially in the opposite direction.Only 11 of the formations with upside breakouts are 5% failures. This meansonce a formation breaks out upward, there is a good chance it will continuemoving up.
StatisticsTable 34.2 shows general statistics related to rounding bottoms. I uncovered243 formations in 2,500 years of daily price data. Of the formations I discovered, about 67% are consolidations of the prevailing trend and the rest arereversals.The failure rate is exceedingly high at 38%. As explained in the Focus onFailures section, I label every formation that is not a consolidation of the trenda failure and include 5% failures too. If we consider only formations that breakout upward, the failure rate drops to a more palatable 5%, which is very good.
40
50
60
Percentage Gain
Figure 34.4 Frequency distribution of gains for rounding bottoms. Almost aquarter of the rounding bottoms have gains over 90%.
474
Rounding Bottoms
Sample Trade
475
Alco Standard Corp. (Office Equipment & Supplies, NYSE, ASM)
91
S O N D 9 2 F M A M J I
A S O N D 9 3 F M A M J | A S O N D 9 4 F M A M | | A S O N D
Figure 34.5 A treacherous example of a rounding bottom that has no left saucerlip. The rounding turn forms after disappointing earnings send the stock into adead-cat-bounce.
Figure 34.6 The double bottom formation is barely discernible within the rounding bottom on the weekly scale.
climb above the handle high (or right cup lip). When it did (point A), or so Ithought, I paper traded the stock and bought in, just as it crested (point B).That turned out to be a minor high. Prices dropped the next day then slowlyrecovered making another handle. A good place to sell is when prices piercethe up trendline in early December.
When he flipped to the weekly chart, it changed the characterization ofwhat he was seeing. On his screen was an obvious rounding bottom. The volume pattern supported the conclusion: receding as prices declined and rounding up as prices rose. So, he decided to wait for the rounding bottom to stopnear the prior saucer lip at about 2 !3/g. When it paused for 2 weeks in February, he knew die formation was primed. The question then became, what wasit going to do next? The only way to find that out was to wait.The following week prices dropped. He waited until prices closed abovethe right saucer lip and headed higher. He knew that to buy earlier risked a
Sample TradeHow do you use the trading tactics to improve your investment performance?Consider what Glen did with the situation shown in Figure 34.6. It was hisdream to become a day trader but he had neither the trading capital nor thenecessary skills for the job. He decided to get there one trade at a time.In December, as he was flipping through his charts, he came across whatappeared to be a mild double bottom. On the daily chart the two bottoms inAugust and November were barely discernible. Was it a valid formation andshould he buy the stock now? Glen decided that the retrace between the twobottoms was not high enough and the two bottoms not clear enough to beworth considering. He justified his action by thinking that if he was having ahard time spotting the formation, then others would have the same trouble. Ifno one spots the formation, then prices will not rise.
downturn in the stock from which it might not recover for a long time. If thestock ventured above the right saucer lip, then the probabilities suggested a
continuing push higher.When prices hit 22, he bought. He looked back at his chart and decidedto put a stop-loss order H below the saucer lip, just below a support level. Hedecided that if the stock hit his stop, in all likelihood it was going down. Content with his investment decision and trading plan, he was confident that hiscareer change to day trading was a simple step away. He was even more confident as the stock climbed. He began looking through brochures from several
companies that offered seminars on day trading. Then the stock declined andclosed below the up trendline. It was a warning sign that anyone could havemissed. Glen certainly did.
476
Rounding Bottoms
35
The following week when he received a call from his broker saying priceshad hit his stop-loss order, he was shocked. Glen booked a loss of about a bucka share. As he watched the stock, he became even more upset. It turns out thestock sold at the low for the week.Three years later, after day trading was over for the day, Glen happenedto review this trade. He decided to pull up the chart and gasped at what hefound. The stock peaked at 66, exactly triple his purchase price.
Rounding Tops
RESULTS SNAPSHOTAppearance
As prices move up, they curve around then breakoutupward.
Reversal or consolidation
Long-term (over 6 months) bullish consolidation
Failure rate
19%
Failure rate if waited forupside breakout
6%
Average rise
41 %, with most likely rise between 20% and 40%
Percentage meetingpredicted price target
69%
Surprising finding
Most of the time prices rise after a founding topcompletes.
Synonyms
Domes, Rounding Turn
See also
Bump-and-Run Reversal, Top; Head-and-ShouldersTops, Complex
When is a top not a top? When it is a rounding top or dome and prices breakout upward. That is the real surprise with this formation as most of the rounding tops have upside breakouts. The failure rate is 19%, a sliver below the maximum rate of 20% that I consider reliable formations to possess. If you wait foran upside breakout, then the failure rate drops to 6%. At first, I set the break-
477
478
Rounding Tops
™
out point as being one-third up the formation. I considered that a 30% retraceafter the dome rounds over as a sign of an upside breakout. Prices pierce manydown-sloping trendlines by that rise and it also gives other investors time torecognize the trend change (so they help push up the price). However, theresults were just too unreal to use (a 0% failure rate and average climb of 58%).The computation neglected other formations that began moving up but ultimately ended lower. I reworked the figures using the dome top as the breakout point. The results are more in line with other formations. Rounding topshave an average gain of 41 %, with a likely rise between 20% and 40%.
Identification Guidelines
479
top. Since the shares are fetching a premium to intrinsic value, more sellersappear. The smart money starts selling, too, and the price drops.Once investors discover the upward price momentum has turned, sellingpressure increases, forcing the price down. Volume may pick up as moretraders try to dump their shares as prices decline. Eventually, the decline endswhen nervous novices toss in the towel and sell their holdings. When all thosewho considered selling their shares have sold, the smart money jumps in andbuys the stock.
Identification Guidelines
TourFigure 35.1 shows a rounding top on the daily time scale that appears irregular with its many price spikes. The stock begins its upward trek in early February. When prices summit in mid-May and start rounding over, the climbamounts to a gain of 22%. In a series of steps prices decline and reach their lowbefore turning up in September. Once prices make the turn, they rapidly climbabove the old high and soar to over 71 by the time this study ends.The reason a rounding turn occurs is not difficult to explain. Prices moveup on bullish enthusiasm confirmed by high volume at the start. Knowing thatprices are climbing, sellers hold on to their shares a bit longer. This forcesdemand to climb along with the share price. However, as prices rise, buyingdemand tapers off and eventually catches up to supply. Prices round over at the
Table 35.1 outlines the characteristics that rounding tops possess. Using eitherthe daily or weekly time scale, prices start moving up from the base of thedome formation. As they move up, they bend over and round off at the top,then continue their rounding turn until they head down and retrace much ofthe prior rise. Buying demand often cuts the decline short before prices returnto where they started.Like the rounding bottom formation, rounding tops have the same volume pattern, but with rounding tops they are opposite the dome shape. By thatI mean volume is lowest at the center of the formation and higher at either end.This is just a guideline, not an inviolable rule. Many times you will see an irregular volume trend over the life of the formation. Pay it no heed; it is still arounding top. What is important is that prices round over and a bowl-shapedvolume trend just adds evidence to the veracity of the chart pattern.Figure 35.2 shows two examples of a rounding top on the weekly timescale. The first one begins at a low price of 12'/i6 in late December 1991. Pricesrise at a gentle rate then the weekly highs begin rounding over near the top. Bylate April prices are heading down again, retracing some of their gains. Pricesonly decline to 14 before heading up on their way to the second formation.Table 35.1Identification Characteristics of Rounding Tops
|an 95
Feb
Mar
Apr
Figure 35.1
May
|un
Jul
Aug
Sep
Oct
A rounding top on the daily time scale.
Nov
Dec
Characteristic
Discussion
Daily or weekly scale
These formations are often long enough to appear on theweekly charts as well as the dailies.
Rounded half-moon shape
The price trend curves beginning from the lower leftupward to the top of the dome then rounds over andmoves down again. At the formation end, prices sometimesbottom somewhat higher than where they started.
Curving volume trend
The volume trend sometimes appears rounded too, butinverted from the dome. In other words, volume isoccasionally higher on either end and shallow in the center.
480
Rounding Tops
Focus on FailuresSears Roebuck (Retail Store, NYSE, S)
481
Figure 35.3 shows an example of a rounding top failure. For 5 monthsprices rise on their way to the start of the formation. Then prices dip for a fewweeks just before the rounding top begins. A person investing in this formationwould expect prices to continue moving higher, resuming the intermediateterm uptrend. However, they would be wrong. Prices reverse and head lower.From the high reached in the rounding top to the low just 3 months laterprices decline by 60%.I could find few technical clues as to why this formation did not performas expected. The 2-week decline leading to the start of the formation is significant as it drops below the intermediate-term trendline, part of which is shownin the figure. Prices recover and move along the trendline during mid-Octoberthrough early November, then rise above it smartly until tumbling below it inmid-January. The first trendline piercing during late September serves as awarning that the end is approaching. Investors were getting nervous aboutholding the stock. Eventually, this nervousness translated into higher volume
91
D 92 F M A
M
A S O N D 9 3 F M A M | |
A S O N D 9 4 F M A M
as prices plummeted.I consider an upside breakout to occur when prices rise above the dometop. Usually prices continue moving higher by more than 5%. When they do
Figure 35.2 Two rounding tops on a weekly time scale. The gentle rounding overgives way to a rising trend most of the time. Note the rounding-appearing volumetrend on the right formation.
not, it is called a 5% failure. Just six formations (6%) fail to move higher than5% before plunging. This suggests that once prices break out upward, theycontinue moving up.
The second dome is not as rounded as the first, but the volume pattern ischaracteristic of rounding tops. Volume is higher at either end of the formation than at the center. Overall, the volume pattern looks like a wide bowl on
Amgen Inc. (Drug, NASDAQ, AMGN)
the chart.
The price pattern of the second dome finishes higher than where itbegins, just as did the first one. From the low of 2013/i6, prices climb to a highof 53 /s a few weeks before the end of this study in July 1996. That is a gain ofabout 260%. The first rounding top has a rise of 210% as measured from thelow in June 1992 to the high reached during the second rounding top in October 1993.
Focus on FailuresAs I was searching for rounding tops in the stock charts, it quickly became
obvious that they act as consolidations of the prevailing trend. The statisticsconfirmed my hunch. Thus, I consider everything that is not a consolidation of
the prevailing trend to be a failure. The reason for this is the same one positedfor the bottom variety. If you buy into a situation believing that prices willleave the formation in the same trend as they enter, you will probably be upset
when prices reverse. Reversals are rare, happening less than 20% of the time,but they do occur.
|un 92
Figure 35.3 A rounding top failure. The piercing of the up trendline (partiallyshown) before the formation began is a clue to the failure of this formation to continue moving up.
482
Statistics
Rounding Tops
483
StatisticsTable 35.2 contains general statistics for rounding tops. Rounding tops aresomewhat rare, occurring only 165 times in 500 stocks over 5 years. Most ofthe formations act as consolidations of the prevailing trend; the remainder arereversals. As explained in the Focus on Failures section, I consider reversals tobe failures of the formation to move in the intended direction. As such, theycomprise most of the failures. If you wait for an upside breakout or for pricesto rise above the dome high, then the failure rate drops to 6%. That is wellbelow the 20% maximum that I consider reliable formations to have.The average rise of successful formations is 41% as measured from thedome top to the ultimate high (when the primary trend changes). This is aboutaverage for bullish formations.
Figure 35.4 shows that the most likely rise ranges from 20% to 40%. Thegraph shows the results from a frequency distribution of gains. The tallestcolumns are the ones with the highest frequency. I consider them to representthe most likely rise. Usually the chart looks more like a bell-shaped curve, butthis one appears irregular with spikes at 80% and 90%. I think the irregularpattern is due to the scarcity of formations. If there were more successfulrounding tops, the pattern would appear smoother.Although rounding tops do not have a measure rule, that did not stop mefrom checking to see if an acceptable gauge is available. I calculated the formation height from the dome high to the right side low and added the resultto the dome high. Only 69% of the formations have prices that move above thecalculated target price. I consider values above 80% to be reliable, so this chartpattern falls short. The Trading Tactics section discusses use of the measurerule in more detail.
Table 35.2
General Statistics for Rounding Tops
30
40
SO
60
70
80
90
>90
Figure 35.4 Frequency distribution of gains for rounding tops. The most likelyrise ranges between 20% and 40%.
The average formation length is 6 months, rather long as far as formations go. This length reinforces the belief that rounding top formations readily appear on weekly time charts.Table 35.3 shows statistics related to breakouts. I consider prices to breakout of the formation when they rise above the dome high (upside breakouts).When you filter the breakouts into the two types, you find that there are 101
upside breakouts and 64 downside ones.I did not consider a rounding top breakout to be that significant exceptfor the direction. The majority of breakouts are upward, contrary to the popular belief that domes represent tops; prices should fall after a rounding topoccurs. That is not what I found with over 100 formations supporting the conclusion. I feel safe basing the performance statistics on those formations withupside breakouts.
Description
Statistic
Number of formations in 500 stocks from 1991to 1996
165
Reversal or consolidation
134 consolidations, 31 reversals
Failure rate
31 or 19%
Failures after upside breakout
6 or 6%
Description
Average rise of successful formations
41%
Upside breakout
101 or 61%
Table 35.3
Breakout Statistics for Rounding TopsStatistic
Most likely rise
20% to 40%
Downside breakout
64 or 39%
Of those succeeding, number meeting or exceedingprice target (measure rule)
For successful formations, days to ultimate high
1 year (371 days)
59 or 69%
Average formation length
6 months (182 days)
Percentage of breakouts occurring near 12-month pricelow (L), center (C), or high (H)
L0%, C5%, H95%
484
Rounding Tops
Sample Trade
For successful formations with upside breakouts, it takes about a year
485
Tandy Corporation (Retail (Special Lines), NYSE, TAN)
(371 days) to reach the ultimate high. That is a long time for a 41% average
gain. We have seen with other formations that large percentage gains takelonger to reach the ultimate high. Rounding tops are no exception but the riseis perhaps more gentle.If you split the yearly price range into thirds to see where the breakoutresides, you discover that nearly all break out within a third of the yearly high.
Just four formations (5%) break out in the center third of the yearly pricerange. With most formations having breakouts in the highest category, thereis no need to map performance over the three ranges. The formations meet theaverage, gaining 41%.
Trading TacticsTable 35.4 shows trading tactics for rounding tops. The measure rule estimatesthe minimum expected price target. Although a measure rule is not supposed
Aug
Sep
to exist, I found that it works 69% of the time. I view values over 80% to be
Figure 35.5 A rounding top with a rising wedge. This formation turned into a
reliable, so in that regard, it comes up short of the mark. When using the