The Double Top is a reversal price pattern & is very common seen in all markets, instruments, time frames, & price ranges. It presents with the immediate background environment as bullish with up-trending price action. The classic Double Top can be an indication that the uptrend is losing strength & may possibly be the end of the advance in prices. The Double Top Reversal usually marks an intermediate or long-term change in trend & is therefore considered to have a definite bearish bias.
Visually the Double Top pattern presents two consecutive highs in price, ‘peaks’ that are roughly equal with the requirement of a moderate trough or swing low in-between. The price level of this swing low establishes what is called a ‘neckline’ & creates the immediate support for the pattern. Traders often refer to this pattern resembling a ‘M’.
Note that in the uptrend there may be many potential double tops in price along the way up, but until significant support is broken, a reversal cannot be confirmed & traders should respect the trend.
Key points to formation:
- Background: price action trending Up
- 1st swing high peak: marks highest price point in the current trend
- 1st swing low trough effort: sellers step in & price declines typically to a significant price area also seen in the background uptrend action. This 1st effort establishes the immediate lower support & defines a ‘neckline’.
- 2nd swing high peak: the advance off the support usually occurs with low volume. Resistance at the previous high is the expectation & aggressive traders will look at volume activity for early signs from the bears. Typically the activity may be not as much selling volume as it is a lack of buyers. Without buyers the price cannot advance. Note that there is NO confirmation of a reversal of trend at this point. The time period between peaks can vary but typically they are in-line with the symmetry of the instrument of choice. The 2nd high may offer a perfect double top in price but the ‘textbook’ range for price is acceptable within 3% of the 1st high price.
- Decline from peak: Traders are looking for volume & selling pressure with the lack of buyers to accelerate the decline off of the 2nd peak. The type of activity seen in volume during the effort back to support is an indication of strength or weakness. Pattern must have a minimum of 2 swing high efforts creating resistance & 2 swing low efforts creating support.
- Support break: even after trading back down to support a trend reversal is not complete. Breaking the support of the lowest swing low price effort of the pattern & with conviction seen in volume completes the Double Top Reversal.
- Support turns into resistance: broken support becomes potential resistance. Often but not always, there is a test of this newly created resistance & this effort offers a final consideration for a short entry into a potential change of trend.
- Price target: measured move of pattern size. Distance between swing low & swing high of reversal pattern added to breakdown line. This spread in price is an implication of the potential for a decline.
While this pattern is fairly straightforward it should be noted that traders often ‘jump the gun’. Not all repeated peaks produce a change of trend & traders need to remember that the trend is in force until proven otherwise. Top formations can take some time and patience is often a virtue. If a trader will give the pattern time to develop and look for the proper clues & then follow the guidelines, this chart pattern can be well-worth the effort of identifying & trading it.
Options for Trading the Double Top as a bearish reversal pattern:
There are 4 methods of trading this pattern & it depends on your trading style.
Most Aggressive traders will be looking for the 2nd peak in price as soon as the first peak shows resistance & the swing low is in place. As the action comes back to re-test this high resistance area aggressive traders will be diligently monitoring the volume action looking for clues to the selling pressure & lack of buyers. Entries in this area can work with a stop placement just above the highest high of the formation. Aggressive traders should be prepared for thrusting action or ‘bump & run’ type price action.
Aggressive traders may wait until a 2nd swing high is made & then monitor the action thru the middle of the reverse pattern. The concept of this option is to identify the reversal price action as being contained in a support/resistance ‘box’. Traders monitor the middle ‘muddy trench’ or 50-50 of the spread in price offered by the pattern for an entry once the bears control. Stop placement can be fairly tight just above the trench zone. An additional option to consider with this set up is to include waiting for 2 solid efforts on support & then consider the muddy trench zone entry. This can be an accurate trade offering an entry looking to capitalize on a breakdown & potentially a new bearish trend but without the risk of the most aggressive option.
Classic traders will look for a short entry with the breakdown of the neckline or immediate pattern support. Stop placement right above the neckline price.
Conservative traders will watch the breakdown & look for a re-test of that new breakdown resistance price to hold for full confirmation of the double top reversal pattern. Stop placement right above the breakdown price. Note that this method of waiting for this pullback may or may not offer an opportunity but statistically it has a high % of success when it does present.
The aggressive trading methods can highly increase the profit potential of any Double Top & may offer more than one entry. However, the trader needs to assess whether the ‘extra’ profits choosing an earlier entry offers a decent risk:reward over waiting for some confirmation of action based on clearing a defined price support. Traders choosing these options should look for strength from sellers in combination with the lack of buyers. It cannot be stressed enough that volume is a major key & an expansion of bearish volume aids confirmation.
False breakdowns do happen & confirmation needed is always a traders’ choice. Several methods that apply here for either intrabar &/or close bar options offered in sequence: breakdown below support price, retrace holds new resistance line, price clears breakdown swing low price, price clears next swing low of background uptrend price action, larger chart combination.
Stop placement considerations for all trade entry choices can be aggressively lowered after the breakdown of the price.
Measured Move Target based on structure of the Double Top Reversal Pattern
- Double Top Pattern measure (subtracted from) BreakDown price = target
- Double Top Pattern measure = (swing high price of pattern (minus) swing low price of pattern)
Since the Double Top Reversal Pattern once confirmed has such a high degree of success in indicating a change of trend, there are additional target considerations based on the knowledge that history repeats. All traders can look for tests on each of the swing lows seen in the immediate background uptrend price action. At any point & for all of these options, traders should gauge the continued conviction of the bears based on momentum. If momentum is strong stick with the trade, if they get ‘lazy’ then consider taking profits & possibly look for a re-entry.
Examples: Double Top Reversal Pattern