But why is the price moving this way? What does the pattern warn about? How often can this pattern be found on a candlestick chart? In this article you will learn what a double top is, and how to trade profitably using this pattern in Forex.
What Is a Double Top?
This is a bearish reversal that warns the trader about a possible trend reversal down at the top. Sometimes, it can be seen in the Forex market, cryptocurrency market, stock market as well as commodity market. It is generally the trading pattern used by the intraday as well as a long-term trader.
The double bottom is a bullish reversal signaling. It creates a chart that forms an upside double bottom at the bottom after a downtrend. This pattern cautions traders of a possible change in the trend upwards.
The double top pattern means that the asset is overvalued. This is also reflected with an increase of price, having little or no correction. After a strong uptrend, the pattern forms two highs at the same resistance level. In some cases, the second high is slightly more considerable than the first. This pattern often shows an intermediate downward correction between the two tops, hence giving it the appearance of the letter M.
After two tops, the asset quote changes direction to down and is the start of a downtrend. If the price reaches the supporting line, the further course of a downtrend will become even more powerful. Sometimes, though, support is provided by buyers and the price goes up – that means there can be false breakouts of support. In this case, the probability of a triple top pattern with the formation of the third price high increases. This pattern is also called three mountains. This pattern’s highs can be placed at the same level or in growing order. The three mountains pattern is formed much less frequently on candlestick charts.
LiteFinance: What Is a Double Top?
Double Top Pattern Formation
It can occur on any timeframe. The greater the size of the timeframe, the stronger is the bearish signal for the reversal of the trend.
The formation of a double top can be divided into five primary stages:
This marks the beginning of the first peak in the chart. At this point, there is a prevailing trend of buying while the price reaches a local or new resistance point.
Correction of the price to the nearest support level. The support in this case is called the neckline.
Formation of the second top. At this stage, even with the pressure of selling, the bulls drive the price up to the top level formed at the first top stage.
Finalizing bearish price reversal. After a new attempt at breakthrough resistance by the buyers, the bears start actively pushing the price down to the nearest support level.
A breakout of the support level signals a trend reversal. Short trades can be opened.
LiteFinance: Formation of Double Top Pattern
How Can a Double Top Pattern Be Spotted?
The double top has three key elements, which are formed in the chart in the form of the letter M:
top,
trough,
top.
Let’s take a look at four stages of double top formation:
1. Top formation.
First, the price continues to grow progressively (the first high is being formed). Trading volumes are growing.
2. Bottom formation.
After reaching a high, the price turns down forming an intermediate support line so-called neckline. At this point, the uncertainty is in the market. The influence of the bulls and bears is equal.
3. Formation of the second top.
The bulls manage to take the initiative and drive the price up, while the price reaches the local support level. When the prices go up, the trading volumes decrease. Just before the quotes reach the first top level, short trades in the market are massively opened. The price then starts going down with increased trading volumes.
4. Breakout of the neckline of the pattern.
The price keeps going down, touches the local support line, breaks it out. And quote-wise speaking, after breaking out of the level, which is a broken out level should check this level and let it fall further. But it’s possible that quotes go lower, without any correction, and the trend keeps developing in the direction in which it’s moving now. Breakout of the neckline is another signal to open short trades.
LiteFinance: How to Identify a Double Top Pattern?
What Does A Double Top Inform Traders?
A double top is a reversal pattern that occurs on price tops and gives an alert to a reversal into a downtrend. The pattern forms allows traders to gain profitable short trades. You can calculate before entry to the trade, based on the pattern in advance, set the stop loss and take profit correspondingly.
Let’s try to consider the pattern in more detail taking an example – XAUUSD. The H4 chart has the formation of a double top. After the formation of the first top, the price started to decline, and accordingly, a local level of support was formed. Then the bulls opened long trades and again the price started moving upwards.
However, when the quotes reached the level of resistance, the price fell intensively and broke through the neckline. In the future, quotes will test a broken support level and will continue to go down.
Opening short trades, based on the trading rules of the pattern of a double top, should be opened after a test of broken out support. The further movement after the profit target depends on the distance from the tops to the neckline. However, at times of the release of important news and in other similar situations, quotes fall even deeper. According to the risk management rules, the stop-loss should be placed above the broken out support level.
