Reversal Patterns. Double Top and Double Bottom
Chart patterns such as double tops are frequently used in the market analysis of stocks, currencies, and commodities. These patterns suggest the likelihood of a trend reversal in the market, typically following a period of significant rallies or declines.
What is a double top (or bottom)
The double top or bottom is a popular pattern used in trading to signal a potential reversal. In a chart, the double top is usually shaped like the letter M, while the double bottom resembles a W. It typically appears after the Head and Shoulders and shares similarities with it in terms of trading volume.
How the double top forms
To identify an uptrend in trading, observe an increase in trading volume at the highest new level at point A. It then must be followed by a price drop to point B with a decrease in trading volume. If the price fails to surpass point A and starts declining after reaching point C, it may indicate a double top.
Reversal price patterns cannot complete until the previous support point at B is broken and the price closes below it. Therefore, the price may move sideways to prepare for a potential uptrend return.
This particular pattern showcases two distinct peaks that are nearly at the same level. Typically, trading volume is more active during the emergence of the initial peak and less active during the formation of the second peak.
When the confirmed price closes below the lowest point (at point B) and there is a higher trading volume, then the pattern is complete. This indicates a reversal of the trend, and it is not common for the price to bounce back once the downtrend resumes.
How to measure the double top
To measure the double top, you can measure the first leg of the downtrend from point A to point B, then measure the length of the downtrend that starts from the middle area between the two peaks at point B.
This measurement can then be transferred to the breakout point’s opposite side as the next decline’s target level.
How to measure the double bottom
When dealing with a double bottom, we measure the height in the opposite direction.
First, we measure the height of the initial uptrend from point A to point B. Then, we measure the vertical length of the uptrend that starts from the middle of the two bottoms at point B. This measurement is used to determine the target level for the next uptrend on the opposite side of the breakout point.
The figure displays two peaks, namely A and C, situated at almost the same level. This pattern is verified when the price breaches the bottom positioned between the two peaks, which represents the model’s height.
At the top C, trading volume frequently subsides, but it gains intensity when the price breaks out at point D.
The price rarely bounces back to the breach level once this pattern is formed. The decline observed after the pattern formation always occurs at the breakout point. This decline is typically equivalent to the distance between the two peaks and the penetration line.
A double bottom in the stock market occurs (1) when prices increase to a specific level and (2) when they then drop to form two distinct bottoms at the same level. Typically, trading activity trends upwards during the formation of the first bottom, followed by a downward trend during the creation of the second bottom.
Once the price surpasses the breakout point, it indicates a shift in a trend toward an uptrend. To validate this reversal, one can observe the trading volume. In a double bottom, the breakout level often serves as a reliable support point for the price.
To summarize, the double top and double bottom patterns are useful to determine the trend reversals and set support levels. To use these patterns correctly, remember the Head and Shoulder pattern and the middle lowest (or highest) point between the tops (or bottoms).
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