Stock Markets Guides

Author: Dylan Soiza

Double Top and Double

Technical traders rely on various data points and indicators to identify trading
opportunities in the markets and aid their decision-making whilst trading. This post
will examine two specific candlestick chart patterns, the double top, and double
bottom pattern. We will look at both how to identify them and the strategies traders
can employ to utilize these chart patterns effectively.

The double top and double bottom trading patterns are among the most common
trading patterns traders will find. These patterns are so common that they serve as
evidence against academics who believe that price movements in the market are

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wildly random. It is therefore prudent for traders of every level to be familiar with
these chart patterns when trading.

This post will reference several found in technical analysis such as support and
resistance levels, RSI, the parabolic SAR, and necklines. If you are unfamiliar with these
terms, it is recommended you read about the important trading terminology you
should know before reading on.

What is the Double Top Pattern

This pattern is formed when a security reaches two consecutive highs with a slight
decline between the two highs. The two peaks are formed above a support level
known as a neckline. This pattern resembles the letter; M; you can see an example of a
double top pattern in the chart below.

This chart pattern signals that a medium to long-term change in the security’s price is
imminent, and the price of that security is likely to begin to fall.

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What is the Double Bottom Pattern?
The double bottom pattern is a bullish technical reversal pattern.

This pattern is the opposite of a double top. It indicates that a potential uptrend in the
price of a security is likely. This pattern is formed when a security experiences two
consecutive lows with a slight increase between the lows. A resistance line will form
in-between the two lows.

As with the double top pattern, this is also referred to as a neckline. The pattern
resembles the letter W; you can see an example of a double bottom pattern in the chart
below.

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This chart pattern signals that a medium to long-term change in the security’s price is
imminent, and the price of that security is likely to begin to rise.

How to Identify the Double Top and Double Pattern

It is widely accepted among technical analysts that technical trading is largely an effect
of wider market psychology. Traders recognize patterns in large numbers and adjust
their trades accordingly. When large numbers of traders are trading on the same data,
technical analysis largely becomes a self-fulfilling prophecy.

Traders should be aware that these trading patterns typically form over long periods of
time.

The patterns do not always clearly resemble the letters M and W, nor do the highs and
lows need to reach the same points for the M or W pattern to have formed. Identifying
these patterns can therefore be quite challenging.

To correctly identify a double top or double bottom pattern, a trader must look for the
following:

1. Identify a general market trend. Since these two patterns indicate a trend
reversal, then the first step for a trader will be to identify a trend that could
reverse. If the market is trending up, traders will be looking out for a double top,
as the market could reverse into a downtrend. If the market is trending down,
then traders will be looking out for a double bottom, as the market could
reverse into an uptrend.
1. Identify a top or bottom. To be a double top/bottom, it is logical that there must
be a first top or bottom. Follow the general market trend until a clear top or
bottom presents itself.
1. Find the neckline. The neckline will be a manually drawn line in between the
two tops or the two bottoms. In double bottoms, this will be a resistance line. In

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 double tops, this will be a support line. This line will help you to confirm the
double top or double bottom and trade it effectively.
1. Neckline breakout. Once the price of the security moves beyond the neckline,
the double top or double bottom has been confirmed. The trader can then
reliably assume that the trend has reversed. At this point, a trader can trade the
double top/bottom with a high probability of success.

False Double Top and Bottom Patterns

The price movements on these patterns can often give the impression that a double
top or bottom is forming, only for the support or resistance lines to be broken and the
pattern to fail.

A false double bottom/top refers to a situation where one pattern is forming, but it
does not bounce off the resistance/support lines (necklines). This would indicate that
the pattern is not genuine, and the trend may not reverse.

Thankfully, one important metric a trader can take into account is to distinguish
between a genuine double top/bottom and a false one.

A trader should examine the time frame between the two tops or bottoms.

The longer it takes for the two to appear, the higher the probability of being a false
pattern. The shorter the time between the two bottoms/tops, the higher the
probability it is genuine.

The uncertainty of double top and bottom patterns forming is one reason why trading
these patterns can be particularly challenging. Let’s now examine how we can trade
double tops/bottoms.

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How to Trade the Double Top and Double Bottom Patterns
There is no magic formula for any trading pattern. No generalized metric or indicator
can tell traders how to trade a specific pattern correctly every single time.

If traders could make predictions that accurately, the number of billionaires on Earth
would increase rapidly. Every trade, every security, and every moment will be slightly
different.

Ultimately, it will be up to the subjective intuition of the individual traders' experience

Generally, there are two ways to profit from these patterns. Traders can either open a
short position on a double top or a long position on a double bottom. Before either of
these actions is taken, the trader should confirm the patterns with other technical
indicators such as the RSI or the parabolic SAR.

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Both of these are momentum indicators, so they will be instrumental in determining
the trend reversal indicated by these two chart patterns.

Traders can use either 'Contracts for Difference' (CFDs) or spread betting during both a
double top or a double bottom pattern.

During a double top pattern, the trader could use either CFDs or spread betting to
open a short position after the second peak of the double top. With a double bottom,
traders can use the same instruments to open a long position after the second bottom.

Reactive/Predictive

As we know, these patterns are established when the neckline resistance/support level
is confirmed.

There are two ways traders can approach these situations. Traders can attempt to
predict that the pattern will be confirmed or react to it once it has been. Both of these
methodologies have their strengths and limitations. Which methodology you pick will
be largely determined by your psychology and the type of trader you are.

Traders with a fader mentality, selling into strength and buying weakness, will try to
anticipate the pattern by stepping in front of the price movement.

Reactive traders will want to see that the pattern exists and has been confirmed before
entering into the trade.

Those traders who take the predictive approach will make larger gains and incur more
risk as they do so.

Reactive traders must pay worse prices to enter the trade and stand to make less profit
from their positions. That said, their risk level is considerably lower as the pattern has
been confirmed by the time they enter into the position.

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Stop Loss

Another issue for traders who are trading these patterns will be where they should
place their stop losses.

Conventional wisdom would dictate that traders should enter their stop losses either
at the top of the double top or the bottom of a double bottom. However, trading the
markets is rarely straightforward, and conventional wisdom usually falls short.

Since these patterns are as common as they are, they are regularly targeted by retail
traders.

Institutions trading the markets are well aware of this and are more than happy to
exploit retail trading psychology to their benefit. Their trading strategy will be to buy
shares in large enough volume to manipulate the price in the direction they want. This
will force weaker retail hands to exit their trades shortly before the price changes
direction again. This can lead to a great deal of frustration for retail traders who exited
a profitable trade with a loss.

It is therefore advised that traders exercise caution when implementing their stop
losses when trading these patterns.

Lastly
Double tops and double bottoms are two of the most prevalent trading reversal
patterns.

While these patterns can be extremely reliable for traders to base their trades on, this
is not always the case. This is why traders always need to look at other technical and
fundamental metrics before making their decisions.

No one indicator or pattern is reliable 100% of the time. The best traders incorporate a
wide variety of different data points and indicators into their decision-making.

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Lastly, when studying charting patterns, it should be noted that it is easy to look over
them in hindsight and detail exactly when you entered and exited a trade.

Doing this in real-time, with the risk of losing real money, is an entirely different
animal.

Individuals learning to trade should not begin trading with large amounts of money
until they have sufficient experience in trading with smaller amounts.

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