The rounded bottom is a powerful pattern, but because it is a relatively calm (although not always) and long-lasting pattern, it often goes unnoticed. A rounded bottom begins with a sell-off, when the price is making lower swing lows and lower swing highs. The price then slowly transitions to making higher lows and higher highs.
The pattern shows that people are really interested are buying the stock. Once the price starts rising more dramatically, more market players notice, causing a surge in buying interest as the stock moves higher out of the rounded bottom. The observant trader gets into the trade while the price is forming the rounded bottom and therefore benefits once more traders take notice and push the price higher. (For more, see: Analyzing Chart Patterns: Round Bottoms.)
Autohome Inc. (ATHM) stock had a recent rounded bottom. The price was moving lower into mid-2016, making big swings that resulted in lower swing highs and lower swing lows. In the second half of 2016, the price started making higher swing highs and higher swing lows. Upon noticing this pattern, a trader looks to buy on the next pullback. It is important to remember that the next swing low will likely be higher than the last, so traders should not be overly conservative with the entry point. In November, the price consolidated after a small decline and started moving back to the upside – that was the signal to enter. This pattern was quite volatile, but the overall rounded bottom structure was still there. (See also: Autohome: An Off-the-Radar Potential Winner.)
It is important to note that the rounded bottom took several months to form, which is typical of this pattern. These patterns can be quite explosive. Therefore, traders should consider the use of a trailing stop-loss for an exit. A simple type of trailing exit is to move the stop-loss up to below a recent swing low after the price has moved above the last swing high. This assures that the stop-loss is only moved up once the stock price has moved up. Traders can continue to do this until the price hits the stop loss.
Clean Energy Fuels Corp. (CLNE) stock has been in a long-term downtrend, but the selling has stabilized and the price is starting to move higher, forming a rounded bottom. This rounded bottom occurs slightly above the 2016 low and has been forming since the start of 2017. The price bottomed on May 31 at $2.18 and then started to make higher highs and higher lows, accelerating to the upside in July. Traders could look to buy a pullback but should remember that the price is likely to stay above the former swing low. Therefore, an entry is likely to develop near $2.50. A stop-loss can be placed below $2.30 or below the major low at $2.18 to give the trade a bit more room. (It is smart to pick a stop-loss before the trade and stick with it.) (For more, see: Clean Energy Fuels Gets Los Angeles Transit Bus Contract.)
Canadian Solar Inc. (CSIQ) shares started transitioning to the upside after the November low ($10.25). The pattern is quite choppy overall, but the May low was significantly higher than the March low and was followed by a sharp rally in June. The next step is to wait for a pullback. The anticipated entry area is near $13.50 (rising short-term trendline and also above the May low). A slop-loss could be placed below $12. Unfortunately, a decent sized pullback may not always occur before the price runs higher. That applies to the pattern in general and not just to this stock. If the price does keep running higher instead of pulling back, then traders will need to look for a trend trading entry, as the rounded bottom will be over. (See also: Sunny Times Ahead for the Solar Sector.)
The Bottom Line
The rounded bottom can be a powerful pattern, but it can be tricky to spot and trade. Traders can wait for the transition to the upside to start, and once it has begun, they can look to buy on one of the pullbacks. These patterns occur over a period of several months, but once the stock starts running to the upside, the opportunity has likely been missed. Trading these patterns is a balancing act between being patient (making sure there is a transition to the upside occurring) but not too passive. No matter the pattern, traders should risk a only small portion of account capital on any single trade. (For related reading, check out: How Do I Build a Profitable Strategy When Spotting a Rounding Bottom Pattern?)
Charts courtesy of StockCharts.com. Disclosure: The author does not have positions in the stocks mentioned.