A double top is the easiest chart pattern. In this post, you will learn how to trade it with the lowest risk and increase the winning rate. Moreover, I will break some of the myths about the double top.
Double top pattern formation
The double top looks like the letter “M.” This is because the double top pattern has two highs formed when the price hits a certain level that can’t be broken. Another essential feature is support or so-called neckline. This double top formation is completed when the price moves back to the neckline after forming the second high. In short, the pattern has four parts to it:
- First high: the market pulls back lower and forms a swing high. At this point, it happens because of significant profit-booking.
- Second high: the market rejects the previous swing high (can be a bit above or below the first high). It indicates increasing selling pressure.
- Neckline: breakdown below support (neckline) signals the sellers are in control — the market is likely to move lower.
- The twice-touched low is called a support level.
You could hear that the second high shouldn’t cross the first one. However, it doesn’t really matter. We can get a tradable chart pattern with the second high slightly higher than the previous one. You have to pay attention to other essential studies to trade double top successfully.
Trading stocks and other assets with a double top chart pattern
The double top pattern is highly reliable when identified correctly. However, it can be highly detrimental when it is misinterpreted. Most technical analysts say the first top should be a rise of 10% to 20%, then the second top should form within 3% to 4% of the previous high, and volume on the ensuing advance should decrease. However, I follow absolutely different approach. First of all, the market doesn’t reverse because we see the double top in the chart. There has to be a fundamental cause for a trend change. So, how and when should we trade the double bottom?
Market reverses if there is a fundamental setup that can be identified by cycles, seasonal forecast, COT (for commodities), insider accumulation, Intermarket forecast, government impact (if any), valuation modeling, backwardation (for commodities), etc. If 80% of mentioned studies give a bearish signal, the pattern will most likely play very well, and we can use our strategies to enter the market. On the other hand, if they generate mixed signals, there is a significant risk that a double top pattern will fail.
Additionally, pay attention to the time and space between the highs — significant “gaps” are more reliable.
Aggressive entry technique
With the aggressive technique, you can profit when other traders get trapped. Let me explain, bullish traders long the market when the price breaks above the first high, but if the price quickly reverses lower, the long traders are “trapped.” So, we can take advantage of it and go short. There are a few rules for this entry:
- First, we need an up-close day before breakout day.
- Then, if the next day price makes a false breakout, we can go short.
- Finally, put a stop loss above the swing failure.
Conservative entry technique
Conservative traders should wait for a qualified breakdown of double top support. What do we call qualified breakout? If the price consolidates in a tight range near double top support and then breaks down, we have our qualified entry.
Note, breakdown without tight consolidation very often gives false signals. So, we want to stick to qualified entry to filter trades and get the highest winning rate. In this case, the stop loss is the high of the consolidation zone. We can set targets by Fibo or Gann levels. Additionally, traders can use 18MA and engage only if the price trades above the moving average.
Is double top a bearish reversal pattern?
Based on all book studies, the double top is a reversal pattern. But, it is just a myth. And, based on my 12 years of experience, I can assure you the double top is also a great trend continuation pattern. So, why not trade it if it is formed in a strong downtrend? This approach offers a lower risk because you follow the trend.
To have a high winning rate while trading double top, follow it when the market is set up for decline. In other words, when there is a fundamental cause for a trend change. Moreover, trading double top as a trend continuation pattern helps to reduce risks. It is a reliable pattern and has an over 75% winning rate.
Top 3 Strategies To Trade Double top pattern [Complete Guide] by Inna Rosputnia
Wishing you a great week!
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