Double top patterns are noteworthy technical trading structures to learn and integrate into a trader’s arsenal. Double tops can enhance technical analysis when trading both forex or stocks, making the pattern highly versatile in nature.
Double Top Pattern: Main Talking Points:
- What is a double top?
- How to identify a double top pattern on forex charts
- Using the double top pattern in trading
- Learn more about trading with technical patterns
WHAT IS A DOUBLE TOP?
The double top pattern entails two high points within a market which signifies an impending bearish reversal signal. A measured decline in price will occur between the two high points, showing some resistance at the price highs. After retracing a portion of the first peak, the market rallies back towards the high of the first peak however, strength in the market is waning and is unable to sustain a break above the first peak.
The slowing momentum may be evidenced through a lagging peak on an oscillator like RSI. Though not required, the market may break above the first peak, even if briefly. A slight and temporary break above the first peak is preferred as it may excite the bulls only to reverse and trend lower. Signs of a bullish shift in IG client sentiment may indicate a secondary top is looming. The neckline is formed between the price low of the valley between the two peaks. A break below this neckline will confirm the double top pattern. The bearish confirmation is specified by a break in the key price support level (neckline) situated at the low point between the ‘tops’.
Similarly, the double bottom pattern reciprocates the double top pattern signaling a bullish reversal. Instead of the confirmation being shown at a break in the key support level, the double bottom occurs at the key resistance highs between the two low points. The double top and double bottom patterns are powerful technical tools used by traders in major financial markets including forex.
HOW TO IDENTIFY A DOUBLE TOP PATTERN ON FOREX CHARTS
Step-by-step guide to identifying the double top pattern:
- Identify the two distinct peaks of similar width and height
- Distance between peaks should not be too small – time frame dependent
- Confirm neckline/support price level
- Use other technical indicators to support double top bearish signal, such as moving averages and oscillators
USING THE DOUBLE TOP PATTERN IN TRADING: TOP TIPS
The double top is frequently used in the forex and equity markets as sell/bearish signals. The charts below provide examples using both markets as references to observe how this pattern is utilized in different ways with regards to trade entry and exit points.
USD/JPY Double Top Chart Pattern:
The chart above represents a weekly USD/JPY chart. The double top pattern is formed after a prior uptrend with the first peak reaching a resistance high in conjunction with an overbought signal highlighted by the RSI oscillator. Following from this peak, the market declined in strength in formed the characteristic dip between the two peaks. The second peak then developed slightly stronger than the previous peak, and even broke the resistance level for a short while. Interestingly the RSI shows no breach/overbought signal (as highlighted) with this break of resistance. This confirms divergence between the market price between the two ‘tops’ and the RSI oscillator showing a slowing of momentum. In addition, divergence of this nature points to a bearish signal.
The entry point of this trade will be confirmed by a close below the neckline which is marked on the chart. The resistance level joining the two peaks may be taken as the stop level (neckline/dotted line) whilst the swing low prior to the double top formation is taken as the limit level. Fibonacci levels may also be implemented for stop and limit levels as opposed to the price action approach. With regards to risk management, this particular trade maintains an approximate 1:1.2 risk-reward ratio.
Ryanair Holdings PLC (LSE) Double Top Chart Pattern:
Stock market volatility (movement) is much less frenetic as displayed by the ‘smoother’ chart construction. The use of an oscillator has been implemented in this stock example to show the diversity of supporting functions that can be used with the double top pattern.
This Ryanair Holdings PLC (LSE) share exhibits a double top that has recently completed its arrangement. This type of trade setup allows the trader to enter the trade after the formation of the second peak to capitalize on a larger move downward as opposed to waiting for confirmation – highlighted above. The stop level is set at the high of the first peak and the limit seen along the neckline of the pattern. The stochastic oscillator is used to authenticate the entry point using the overbought sign seen above.
In summary the double top pattern is commanding if correctly utilized and understood. Proper support from other technical tools enhance the characteristics of the pattern to allow traders to implement this in various markets.