Recommended
Encyclopedia
of Chart Patterns
staff
review of more
books like this
|
 |
|
Friday September 05, 2008 |
Rounding
Bottom
Technically speaking, a 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.
Why Does It Happen?
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". So, why does this happen? 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
longer-term. 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.
How are Technical
Measures and Targets Derived?
Unlike head and shoulders bottom patterns, 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.
Rounding Bottom for Rite Aid
There was a time when Rite Aid (RAD) was among the greatest momentum stocks
in the land. Several quarters of strong results coupled with a terrific
management team pushed the stock to one new high after another -- until it was
revealed that the earnings were an illusion and the management team would have
to go. By July 11, 2000 investors had slashed the stock from better than
$22 to $8.50. That day a new odyssey began with the legitimate real
earnings and full disclosure of just how bad previous reports had really
been. That day the company reported a staggering loss of $238 million or
92-cents per share for the quarter and $1.1 billion or $4.45 per share for the
year. Wall Street analysts rushed for the exits with earnings revisions and
a slew of negative commentary. The stock slumped to $4.13 by July 27 and
$3 by September 21. There was a brief rally to $4.13 by November 2 but by
the time Rite Aid reported a wider than expected loss on November 10 the stock
was once again on the move lower. The stock traded to $2.46
on November 26. Once again the stock rallied to the $4 level two weeks
later but weak same store sales and general weakness in the retail sector sent
the stock to a fresh new low at $1.81 on December 29. The news got
better in the new year with Rite Aid reporting smaller losses and stronger
pharmacy sales. Rite Aid shares pushed to $4 on January 12 but sellers
quickly returned and a decline back to $3.31 occurred just a week later.
Once again, the decline proved short-lived as news of a convertible debt
offering sent the stock back the $4 level by February 6. There was more
weakness on news that former Rite Aid executives had been named in a fraud suit
but buyers proved resilient and the stock began to climb. By March 5 the
stock had reached $6.
Vital Signs
-
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.
The final two patterns left to
examine are wedge formations. Let's take a look at the
rising wedge.
rounding
top 
rising
wedge
|
|
