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ROUND TOP & BOTTOM


American Express' Rounding Top

01/23/01 08:28:24 AM
by David Penn

The rounding top in American Express has taken almost all of 2000 to develop. Will the upside breakout be worth the wait?

Security:   AXP
Position:   N/A

I've taken to looking at Dow stocks of late, the Dow being my first exposure to equities years ago when I thought the "Dogs of the Dow" strategy was my ticket to a private island in the Pacific. One of the perennial knocks on Dow stocks is that compared to the fire-in-the-veins Nasdaq stocks, Dow equities just don't do very much. However, a counter to that jab may be that because Dow equities are less volatile, a somewhat longer time horizon makes sense in analyzing their price movement.

Starting near the top of the list, I took a somewhat longer-term look at each of the DJIA components and found a potentially interesting rounding top developing in American Express (AXP). A rounding top formation is considered a long-term, bullish consolidation pattern, with "long-term" suggesting up to six months. The formation looks pretty much like it sounds: a dome or upside down bowl shape formed by gradually rising, then gradually declining prices. Rounding tops might also be considered longer-term formations insofar as they tend to develop over a period of time that is long enough to allow the rising and falling action of prices to be rounded rather than forming a sharp angle at the top.

Prices advance then decline in a smooth rounding fashion (1) before breakout. Volume, heavy as the formation begins, recedes as prices peak and grows as prices decline (2).
Graphic provided by: MetaStock.
 
Like many stocks, American Express started off 2000 on a difficult note, as a January advance was followed by a precipitous correction in February and March. From this year-to-date low, American Express rallied, advancing from about 40 to over 63 by late September. The September highs came to represent a year-to-date peak as prices soon began a 22% descent over the fall and winter. January has seen prices rally off of historic support at 46 in a series of bullish trading sessions backed by a rising trend in volume.

As the rounding top formation develops, the right-side curve tends to continue downward until most of the gains of the left-side, upward curve are retraced. It is after prices complete this retracement (often referred to as the "rounding turn") that traders can begin looking for breakouts. Truth told, the "rounding turn" need not fully retrace all of the earlier gains from the left side of the rounding top. Often renewed buying interest that leads to the upside breakout is strong enough to keep the right side of the rounding top from retracing all of the gains of the left side.

What does a breakout from a rounding top look like? Generally, prices need to close above the highest value in the formation before an upside breakout can be confirmed. The advance toward this point tends to begin as volume increases and the right side of the formation--which was trending down to "round out" the top--reverses and begins to climb. A measurement rule for rounding tops suggests adding the formation height to the highest value in the rounding top (the formation height is calculated by subtracting the lowest value on the right side of the dome from the peak of the dome). In the case of American Express, if we consider the January advance to represent the first steps of the move toward breakout, the formation height is 16. Add this to the highest value in the formation (the October 2nd year-to-date high of 63) and a price target of $79 per share emerges.

I should point out that the breakouts from rounding tops do not come swiftly; again, rounding tops tend to be longer duration formations. In fact, Bulkowski (in his "Encyclopedia of Chart Patterns") suggests that ultimate highs of successful rounding tops are reached as many as 370 days after the breakout. All the same, given the fact that American Express' rounding top was at least 150 days in the making, the fact that the ultimate high may be as much as a year away should be something less than a complete surprise.



David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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Date: 01/26/01Rank: 5Comment: test from Sean
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