Double top and double bottom patterns are the technical chart patterns. They are commonly used by traders to identify potential trend reversals in the stock prices. These patterns are easy to trade and has the potential of earning you handsome returns on your trade.
By understanding how to identify and trade these patterns, traders can make informed decisions and potentially profit from market movements.
In this guide, we’ll take a closer look at what these patterns are, how to identify them, and how to effectively trade them.
Understanding the Double Top and Double Bottom Patterns
The double top and double bottom chart patterns are technical analysis patterns. They are formed when the price of an asset or a stock reaches a certain level twice before reversing direction. Thus, these patterns can be used to identify potential trend reversals and can be traded using a variety of strategies.
The double top pattern occurs when the stock price reaches a high point twice before falling to lower price levels. This is a bearish pattern because it indicates the impending fall in stock price in near future. It is seen after an ongoing uptrend in the stock prices.
The double bottom pattern occurs when the price reaches a low point twice before moving higher. Seen at the end of previous down trend, this bullish chart pattern indicates the possibility of stock price moving higher in future.
It is not necessary for the tops or the bottoms to be at the same level on the charts to make these patterns. There can be some variations.
Identifying the Double Top and Double Bottom Patterns
These patterns are easily identifiable on a price chart. They are reversal patterns usually seen when a trend is matured and coming to end. So, it is important to be vigilant while doing your stock research.
The double top pattern is formed when the price reaches a high point, retraces, and then reaches the same high point again before dropping.
As the name indicates, the stock prices form two peaks on the chart. The stock starts rising with good volumes and retraces back from a resistance point leading to formation of Top 1.
After falling to a certain level, the stock finds support and makes another attempt to move higher but with low volumes and meets with selling pressure after reaching at the resistance level of Top 1. This is because the sellers are aware of the level of Top 1 resistance. Now as the stock could not cross this resistance, the new downtrend starts in the stock, and it starts moving lower.
The double bottom pattern is formed when the price reaches a low point, retraces, and then reaches the same low point again before rising. It is a bullish pattern and a signal to buy the stock. In this pattern, the stock declines with good volumes, finds support and retraces back leading to formation of Bottom 1.
Traders can use technical indicators such as moving averages and trend lines to confirm the pattern and make trading decisions.
It meets the resistance at higher level and declines again, now with low volumes and retreats at support forming Bottom 2. You enter the long trade when the stock breaks out with higher volumes.
Confirming the Double Top and Double Bottom Patterns
While the double tops and double bottoms are easily identifiable, it’s important to confirm the patterns before making any trading decisions.
Traders can use technical indicators such as moving averages and trend lines to confirm the pattern. For example, if the price breaks below the neckline of the double top pattern, it confirms the pattern and traders can enter a short position.
Similarly, if the price breaks above the neckline of the pattern, it confirms the pattern and traders can enter a long position.
How to Trade Double Tops and Double Bottoms
Trading the double tops and double bottoms can be a profitable strategy for traders. These patterns occur when the price reaches a high or low point twice before reversing direction.
To trade these patterns, traders should first identify the pattern and then confirm it using technical indicators. Once the pattern is confirmed, traders can enter a position in the direction of the reversal.
It’s important to set stop-loss orders to manage risk and take profits at predetermined levels.
With practice and experience, traders can become proficient at trading these patterns and increase their chances of success in the markets.
As a trader, you would trade the stock by creating short position in the stock when it breaks down from the lower support line (see above fig). Ideally you enter the trade immediately after breakdown from the support line.
The thing to take care here is that when the stock breaks down, the volumes should be higher than normal otherwise it could be a false breakdown.
Look to enter the trade on breakout. Target for the trade is the sum of difference between resistance and support price level and the resistance price level. Fix your stoploss just below the lower support line.
Managing Risk and Setting Targets
When trading double top and double bottom patterns, it’s important to manage risk and set targets for profits. Traders should always use stop-loss orders to limit potential losses if the trade goes against them.
Stop-loss orders can be placed below the bottom line or above the top line, depending on the direction of the trade.
Traders should also set profit targets based on the size of the pattern. find the difference between the prices at the upper resistance line and the lower support line. Reduce this difference from the price at the lower support line and what you get is the target price for your short trade.
By managing risk and setting targets, traders can increase their chances of success and minimize potential losses.
Conclusion
Both the double top and double bottom chart patterns are easily recognizable and tradable. They happen after a sustained trend and are indicative of the end of that trend.
They can be quite reliable and profitable. The only requirement is timely spotting of the pattern and entering the trade.
