A double top is a bearish technical pattern signalling a possible reversal of an uptrend. It occurs when an asset's price reaches a peak level twice, with a slight dip in between, indicating that the upward momentum may be weakening. Confirmation of this pattern happens when the price drops below a support level, which corresponds to the low between the two peaks.
What is double top pattern?
The double top pattern is a chart formation suggesting that an existing uptrend might be nearing its end, with potential for a reversal. This pattern usually appears near the conclusion of a bullish phase, visually represented by two peaks formed back-to-back. The double top is often contrasted with the double bottom pattern, which signals a reversal from a downward trend. While both patterns highlight trend shifts, the double bottom is characterised by a positive price movement, forming a mirror image of the double top.
Imagine looking at a price chart and spotting two distinct peaks, both occurring at approximately the same price level. These peaks resemble the letter “M,” hence the name “Double top.” Here is what you need to know:
- Formation: The double top pattern typically appears after a prolonged uptrend. It signifies a transition from bullish sentiment to bearish sentiment.
- Confirmation point: The pattern is complete when prices decline below the lowest low between the two peaks. This lowest low acts as the “confirmation point.”
- Neckline: The neckline is drawn between the price low of the valley formed between the two peaks. A break below this neckline confirms the double top pattern.
- Momentum indicator: Traders often observe a lagging peak on an oscillator like the relative strength index (RSI) as evidence of slowing momentum.
What does a double top pattern tell you?
A double top pattern is an ideal technical indicator that shows investors that a stock might be on the verge of a downtrend and its price will start falling. The double top patterns form with two price peaks that are almost the same, indicating that the stock tried to push higher from the current price level but failed, further positioning it to start falling in price. Hence, the double top chart pattern is considered a significant trend reversal pattern, indicating the reversal of an uptrend to a downtrend.
Investors look for signs of a double top candlestick pattern and verify it when the stock price falls below the stock’s support line following its failure to rise above the second price peak. The trading volume of a stock also rises after the stock price line breaches the support level. Thus, investors and traders always verify a double top pattern before entering or exiting stock holding.
Advantages of double top pattern
Let us explore the advantages of top pattern:
1. Reliability
The double top pattern is one of the most reliable chart patterns used in technical analysis. Its formation is easily identifiable on price charts, making it easier for traders to recognise potential reversal signals.
2. Confirmation
Unlike some other chart patterns that require additional confirmation signals, the double top pattern provides a clear confirmation of a trend reversal once the price breaks below the support level.
3. Risk management
By identifying a double top pattern early, traders can implement risk management strategies such as placing stop-loss orders above the second top, minimising potential losses if the reversal fails to materialise.
Disadvantages of double top pattern
Let us explore the disadvantages of a double top pattern:
1. False signals
While the double top pattern is generally reliable, it is not immune to false signals. In some cases, the price may form a double top pattern but continue its upward trend instead of reversing, leading to losses for traders who shorted the security prematurely.
2. Subjectivity
Interpreting chart patterns, including the double top pattern, involves a certain degree of subjectivity. Traders may differ in their interpretation of whether a pattern qualifies as a double-top, leading to inconsistent trading decisions.
3. Market volatility
High levels of market volatility can increase the likelihood of false signals or failed reversals, making it challenging for traders to accurately predict price movements based solely on chart patterns.
Additional read: What is Fear and Greed Index?
What do traders think about the double top pattern?
Traders value the double top pattern as an ideal technical indicator as it helps them identify a potential trend reversal in the price of a stock. The pattern suggests that the price has hit a resistance level twice but failed to break through, signalling that buying pressure may be weakening. The stock loses demand because of the weak buying pressure, and the share price starts falling, creating a bearish trend. Traders confirm the double top pattern when the stock price breaches the trough between the two almost identical price peaks.
The identification of a double top pattern helps traders and investors better manage their investments. They may sell the shares to book profits, cut losses, or wait for the share price to go down to make a fresh entry. However, traders often use the double top pattern with other technical indicators or analysis methods to increase the accuracy of trading decisions.
How to trade using the double top pattern?
Traders identify and verify a double top pattern when the stock price breaches the trough between the two price peaks, indicating that the share price will fall from the current levels. Traders then use various tools and investment strategies to ensure they capitalise on the potential trend reversal. One of the most common strategies is to place a stop-loss order above the second peak of the pattern to protect against unexpected price movements and limit potential losses.
Some traders enter into short positions, which helps them earn profits from the fall in the stock price. Furthermore, they constantly monitor and adjust their investment based on the strengths and weaknesses of the double top pattern in real time.
Difference between a double top pattern and a double bottom pattern
Here is a detailed table for you to understand the difference between a double top pattern and a double bottom pattern:
Aspect |
Double top pattern |
Double bottom pattern |
Definition |
A stock chart pattern that indicates a trend reversal from an uptrend to a downtrend. |
A stock chart pattern that indicates a trend reversal from a downtrend to an uptrend. |
Formation |
Consists of two peaks at roughly the same price level, separated by a trough. The shape resembles an ‘M.’ |
Consists of two troughs at roughly the same price level, separated by a peak. The shape resembles a ‘W.’ |
Confirmation |
Confirmed when the price falls below the trough between the peaks. |
Confirmed when the price rises above the peak between the troughs. |
Trading volume |
The trading volume increases after the formation. |
The trading volume also increases after the formation. |
Entry point |
Generally short selling or profit booking. |
Generally buying for the long-term. |
Stop loss |
Placed above the second peak. |
Placed below the second trough. |
Conclusion
In conclusion, the double top pattern is a valuable tool for traders seeking to identify potential trend reversals in the securities market. Its formation, characterised by two consecutive peaks followed by a reversal, provides a clear signal of a shift from bullish to bearish sentiment. While the pattern offers several advantages, including reliability, and clear confirmation signals, traders should be mindful of its limitations, such as the possibility of false signals and subjective interpretation. By combining the analysis of double-top patterns with other technical indicators and risk management strategies, traders can enhance their decision-making process and improve their chances of success in the dynamic world of stock trading.
