Double Top and Double Bottom

Apr 27, 2009: 11:21 PM CST

The Double Top and Double Bottom patterns are quite common and easily recognizable chart patterns which occur on all timeframes and in all markets.  Let’s take a closer look at this classic reversal pattern.

Ideal Double Top Pattern Double Top Pattern

The image on the left represents an ideal Double Top Formation (which is the mirror image of a Double Bottom) while the chart on the right represents a Real World example.

The Double Top is a Reversal pattern that is expected to occur after a lengthy upward advance in price.  Buyers push prices to new highs on the first impulse up and then profit taking pushes price to a normal down-swing.  Buyers step back in on the pullback but are unable to exceed the previous peak in price as sellers begin to unload their inventory, contributing to the supply/demand imbalance as price fails to make a new high and then reverses at the prior resistance level.

How to Trade a Double Top or Double Bottom

Generally, you won’t be able to act upon the pattern until price begins to reverse at the prior resistance level.  You can increase your confidence that the pattern is forming if you find one or more of the following:

  • Price is ‘bumping up’ against a prior resistance level from a past price
  • Price is ‘bumping up’ against a key moving average on a particular timeframe
  • Price has achieved a Fibonacci or other Price Projection Target
  • A Negative Momentum Divergence has formed on the Second Price Swing
  • A Volume Divergence has formed on the Second Price Swing (lower volume than on the first swing)

Once you believe price is experiencing a Double Top formation, enter short as closely as possible when price begins to inflect (turn down) at the previous resistance price.  Place your stop just beyond the prior swing high.  If the pattern resolves into a true trend reversal, you will stand to profit from the pattern as a low-risk trading opportunity.

You can obtain a Minimum Price Objective by measuring the distance from the resistance line (price at which the Double Top forms) down to the support price at the middle swing of the pattern.  Take this value and subtract it from the middle-swing support price to obtain an initial target.

All rules would be reversed for trading a double bottom.

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