Identifying chart patterns, like the double top and double bottom, can be very beneficial in finding profitable trading setups. These patterns can serve as additional confluence to confirm the market direction and provide specific entry setups. This article will discuss how to spot the double top and bottom technical analysis patterns and provide ideas on how to trade these as reversal patterns.
Double Top Pattern
The double top pattern is a bearish reversal pattern that can appear on any candlestick chart and any time frame. Thus, day and swing traders can incorporate them into their trading strategy. It is available on charts for all types of markets, including the stock market, forex, or futures trading market.
Like the double bottom that we will discuss later, it is known as one of the most straightforward reversal patterns to spot on a chart and is a sign that a stock or equity’s price may be near its exhaustion point. The pattern looks like the capital letter “M” on a chart. See the images below.
To summarize how the pattern is formed on a chart, imagine two peaks of approximately the same height. These peaks appear very close together, like two mountain tops next to one another. Double tops usually occur in an uptrending market where the price moves upward for some time.
Then, it had a slight pullback, which forms the first peak. Then, the price tried to move upward, but it could not move past the price level of the first peak. This resistance creates a second pullback that causes the second peak to form.
Ultimately, this signals that the equity’s price cannot move past the top level and that the sellers have jumped into the market to drive the price downward. Hence, this is why double tops signal a reversal. In this case, the buyers had two chances to continue to move the price upward but failed at each attempt.
Double Bottom Pattern
The double bottom is a bullish reversal pattern, similar to the double top except opposite it. It can also appear on all candlestick charts across all time frames. Traders can choose to use this chart pattern no matter what market they are trading in (whether it be stocks, forex currency, or the futures market).
Its simple pattern looks very similar to a capital “W” on the chart and is a sign of reversal to the upside.
To find the pattern, look for two low valley areas with approximately the same low point and pretty close together. Double bottoms usually appear in a down trending market, where the price moves downward for some time.
Then, it slightly moved upward, forming the first valley point. Then, the price tried to move down again, but it could not move past the price level but moved upward again, causing the second valley point.
Double bottoms signal that the equity’s price is receiving support at that bottom level and that the buyers have potentially jumped into the market to move the price upward. Hence, the buyers are rejecting the move of the stock downward.
With the double bottom, the sellers did not succeed with their two chances to continue to move the price lower.
How to Trade These Chart Patterns
Now, let’s discuss how to trade these patterns.
Double Top Trade
Once we have identified the double top pattern on a chart, the next step is to look for the lowest point that the stock price retraced when it created the M pattern.
Once identified, the next step is to wait for the price to break and close below the low point on the chart. Once the price breaks this low point, enter a short position as you expect the price to continue reversing from the upward trend.
See the example below of the low point of the retracement (pullback) and where to enter a short position.
In terms of risk management, place the stop loss at the highest price of the peaks.
The take profit can then be set at the next level of support or resistance.
Double Bottom Trade
Now, let’s look at the double bottom example. It is very similar to the double top example. First, identify the double bottom pattern on a chart. Next, look for the highest point that the stock price retraced when it created the W pattern.
Once identified, the next step is to wait for the price to break and close above the high point on the chart. Once the price breaks this high point, enter a long position as you expect the price to continue reversing from the downward trend.
See the example below of the high point of the retracement and where to enter a long position.
Regarding risk management, place the stop loss at the lowest price reached (the valleys).
The take profit can be set at the next level of support or resistance.
Additional Considerations
The critical thing to remember when choosing to trade either the double top or double bottom strategy is to evaluate the market’s current strength to ensure a strong reversal. Sometimes, the market wants to continue the trend, not reverse it. So, failed setups could occur. Before entering a trade, it is best to wait until you can confirm true strength in the reversal direction.
You also want to ensure that the market is not ranging up and down. Double tops and bottoms can form within ranges or during consolidation periods. If in consolidation, then you may want to stay out.
One additional item to note is that even though these patterns are called double tops and double bottoms, they are essentially developed from the retest of supply and demand zones on a chart. Our trading website has many more videos and information to help you along your trading journey.
Summary: Double Top and Double Bottom
These bearish ‘M’ and bullish ‘W’ patterns offer easy trading setups that beginner and novice traders can identify on a chart. It is a straightforward technique that can signal a reversal in the current market trend.
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