17# Rounding Bottom Reversal
Rounding Bottom is a decline to a new low on strong volume, several weeks of light trade with limited downward progress, several more weeks of light trade with a decided upward bias, followed by a sharp move higher on strong volume.
Rounding Bottoms 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.
• Symmetry is important. The most reliable rounding bottom patterns do not stray from the confines of a tight semi-circle and usually resemble head and shoulders top patterns with two left shoulders, one head and two right shoulders. Obviously askew patterns should be avoided.
• It is important that volume decline on each successive move lower and begin to increase as the stock moves higher. The weak volume on declines and rising volume on rallies is a good indication that accumulation is at work.
• Upside breakouts often lead to small 2-3% rallies followed by an immediate test of the breakout level. If the stock falls below this level (now support) for any reason the pattern becomes invalid.
Like the Rounding Top pattern, the Rounding Bottom is often mistaken for its head and shoulders counterpart. This is
because the rounding bottom has a lot of the same parts. Both the rounding bottom and head and shoulders bottom have a
series of peaks and valleys and declining volume throughout the pattern. Of course the difference is that the rounding
bottom has what appears to be multiple "shoulders".
Like the Rounding Top, Rounding Bottom patterns are almost deceptively simple in nature. They are all about the orderly transfer of shares from anxious sellers to serious, value minded longer-term investors. Through a series of peaks and valleys sellers are slowly (almost painfully so) removed. The first part of the pattern will always take shape after an extended decline to new lows. Against the backdrop of very negative fundamental news, sellers become anxious and willing to sell their shares for progressively lower prices. At some point a particularly negative news development such as an earnings warning, product delay or key executive departure hits the news wires and the stock slumps to a new low on huge volume.
One by one Wall Street analysts rush to cut estimates and make disparaging comments and the free fall in price continues.
But to the surprise of many, the selling is severe but oddly brief.
The reason for the stock strength is that longer-term investors are beginning to accumulate large positions for the longerterm.
Days later the stock moves higher on good volume. This brief rally in price affords a new selling opportunity for those that did not exit ahead of the first major decline and the price action reverses creating a small resistance level (reaction high). Once again the stock moves lower, testing the most recent new low before buyers mysteriously step-in and support the stock.
A rallies ensues and a move back to the reaction high, now key resistance occurs. Normally this type of impressive price action would be enough to make sellers re-think their strategy but the fundamental news is terrible and just days later the stock is rocked by another negative development. This time the stock moves to a fresh new low but volume is noticeably less than the previous two declines.
After a few sessions meandering at the new lower levels, the stock begins to rebound on better volume on the first piece of good fundamental news in several weeks. The rally lasts for a few sessions but it is stopped dead in its tracks at the short term resistance level. Another decline begins on more bad news but it too is short-lived and a rally back to resistance occurs. This process is repeated one more time before sellers get the idea that perhaps the stock is not going to move significantly lower.
Anxiety levels grow for short sellers and longer-term holders that purchased the stock at higher levels begin to feel better about the stock. The idea is that if the stock is not declining amid the current stream of bad news it must be headed higher – and they are unwittingly correct. In the days ahead more good fundamental news hits the news wires and the stock explodes higher. Weeks later the stock trades back to longer term resistance levels.
The rounding bottom is a long-term reversal pattern that is best suited for weekly charts. It is also referred to as a saucer bottom, and represents a long consolidation period that turns from a bearish bias to a bullish bias.
1. Prior Trend: In order to be a reversal pattern, there must be a prior trend to reverse. Ideally, the low of a rounding bottom will mark a new low or reaction low. In practice, there are occasions when the low is recorded many months earlier and the security trades flat before forming the pattern. When the rounding bottom does finally form, its low may not be the lowest low of the last few months.
2. Decline: The first portion of the rounding bottom is the decline that leads to the low of the pattern. This decline can take on different forms: some are quite jagged with a number of reaction highs and lows, while others trade lower in a more linear fashion.
3. Low: The low of the rounding bottom can resemble a "V' bottom, but should not be too sharp and should take a few weeks to form. Because prices are in a long-term decline, the possibility of a selling climax exists that could create a lower
4. Advance: The advance off of the lows forms the right half of the pattern and should take about the same amount of time as the prior decline. If the advance is too sharp, then the validity of a rounding bottom may be in question.
5. Breakout: Bullish confirmation comes when the pattern breaks above the reaction high that marked the beginning of the decline at the start of the pattern. As with most resistance breakouts, this level can become support. However, rounding bottoms represent long-term reversal and this new support level may not be that significant.
6. Volume: In an ideal pattern, volume levels will track the shape of the rounding bottom: high at the beginning of the decline, low at the end of the decline and rising during the advance. Volume levels are not too important on the decline, but there should be an increase in volume on the advance and preferably on the breakout.
A rounding bottom could be thought of as a head and shoulders bottom without readily identifiable shoulders. The head represents the low and is fairly central to the pattern. The volume patterns are similar and confirmation comes with a resistance breakout. While symmetry is preferable on the rounding bottom, the left and right side do not have to be equal in time or slope. The important thing is to capture the essence of the pattern.