A rounding bottom is a U-shaped pattern, just like the U shape found in the cup and handle chart pattern. Rounding bottoms tend to be observed towards the end of down price trends and can signal a price reversal to the upside.
Many traders therefore use the pattern to better capture buying opportunities.
In the early stages of the pattern, the asset price has reached a resistance point and various sellers have entered the market. The excess supply of the asset created by the selling forces the price down, though this technical downward price pressure proves temporary.
The bottom of the U shape represents a consolidation phase and is generally characterised by lower trading volumes.
Buyers soon come in to take advantage of the lower prices and the asset price then rises again in the second, upward phase of the U, amid higher demand for the asset. Once the price moves back above the starting point of the prior fall, the pattern is complete.
With the rounding bottom pattern complete, traders look for a breakout to the upside as a signal to implement buy trades. A rounding bottom can therefore be a technical signal that buyers have taken the reins from the sellers in dominating a given market.
The upward breakout from this pattern is a bullish signal as it could point to a major new upward trend for the asset.
Traders tend to look to implement buy orders around the point where the pattern completes. Higher volumes at this point should confirm that a true price breakout is occurring. One strategy then, could be to wait until the price closes above the upper end of the pattern on higher trading volumes.
We would also want to put on a stop-loss order to guard against a retrace in the price. For the stop loss, we could choose points at certain recent lows, or nearer the absolute low of the U shape itself.
Trading the rounding bottom
As an example, suppose we were tracking the share price of Ford Motor Company. On a recent spike, we observe the price at $11.11. However, the price subsequently drops and then trades within a consolidation phase, with $9.80 as its lowest point.
This low point becomes the bottom of a U-shaped curve. As buyers come in, the price eventually climbs back to $11.11 once again, completing the pattern.
Noting a breakout on higher volumes at around this level, we initiate a buy trade at $11.20. We also implement at stop-loss order at $10.50, just in case of a retrace. However, as we anticipated, the share price climbs fairly sharply on the same day that we open our position.
We close out the position at the end of the trading day when the share price is at $12.25, highly pleased with our trade. We preferred not to carry on holding the position into the next trading day.
Traders typically use the price distance between the bottom of the U shape and the breakout level to calculate a profit target for their buy trade.
While we chose to exit the trade with a profit of $1.05 per share, a common approach would have been to set the profit target at $1.31, the difference between the $9.80 trough and the $11.11 breakout level.