The double top pattern is one of the most well-known and reliable reversal patterns used by technical analysts and stock traders. Forming after an uptrend, this pattern signals a potential shift in momentum from bullish to bearish.
What is the Double Top Pattern?
The double top pattern is a reversal chart pattern that forms after an uptrend and signals a potential reversal to a downtrend. As the name suggests, it is identified by two distinct peaks or “tops” in the price chart at approximately the same price level.
Specifically, the double top pattern forms through the following stages:
- Price is in an uptrend
- Price forms the first top as bullish momentum starts to slow
- Price declines for a time, finding support
- Price rallies back up to the same peak level, forming the second top
- Support breaks as selling pressure overwhelms buying pressure
- Price declines again, confirming the reversal
Once the second peak forms, technical analysts watch for a breakdown below support, which confirms the double top reversal. The minimum decline to confirm the pattern is the distance from the double top to the support level or “neckline”.
In an ideal scenario, the two tops will be precisely at the same price. However, the formation remains valid even if the tops are near the same price level. Generally, a 3% difference or less is acceptable.
How to Identify the Double Top Pattern
When scanning charts for potential double top patterns, focus on the formation of two distinct peaks at roughly equal prices after an uptrend. Here are the key characteristics to identify:
- Prior uptrend – The double top is a reversal pattern, so there should be a significant uptrend leading up to the first top.
- First top – The rally peaks and starts to decline as bullish momentum wanes. Often there will be decreasing volume on the first top compared to the uptrend.
- Decline – Price drops for a period, establishing a support level known as the “neckline”. The decline should be at least 10-20% from the first top.
- Second top – Price rallies back up to around the same peak level as the first top. Volume may again decline on the second top.
- Support break – Once the second top forms, watch for a break and close below the support neckline. This confirms the double top reversal.
- Price target – The expected decline is approximately the distance from the tops to the neckline. However, chartists watch for support levels, resistance, or other patterns that may alter the projection.
When identifying double tops, it’s ideal to see confirmation through support breaks, volume, divergences with technical indicators, or other signs the uptrend is exhausted. We’ll explore examples next.
Double Top Chart Examples
To better understand double top patterns in action, let’s look at some real chart examples.
Example 1
[Insert chart image here]
This first example shows a nearly perfect double top formation in stock ABC.
We can see the clear prior uptrend leading up to the first peak at $55 in August 2018. Price declines, finding support near $45 in September 2018. This establishes the neckline at $45.
In October 2018, price rallies back up to peak just above $55, matching the first top almost exactly. With this second top in place, we look for a support break below $45 to confirm the pattern.
In November 2018, price drops sharply below the $45 neckline, confirming the double top reversal. The projected decline is around $10, the distance from the tops to the neckline.
Example 2
[Insert second example chart image]
Here’s another great example on a stock XYZ chart. Again we see the prior uptrend leading up to two distinct tops near $80 in June and August 2020.
The neckline support forms near $68. When this support breaks decisively in September with heavy volume, the double top reversal is confirmed.
Notice that RSI formed lower highs on the second top, reflecting bearish divergence. The volume bars also shows heavier selling volume on the breakdown for additional confirmation.
How to Trade the Double Top Pattern
Now that you know how to spot the double top pattern, let’s discuss some strategies for trading it.
Here are some guidelines for trading double tops:
- Enter on confirmation – Wait for a clear break and close below the neckline before taking a short position. Don’t anticipation the breakdown.
- Place stop loss above pattern – Once short, place an initial stop loss a little above the second top. Move the stop down as the trade moves in your favor.
- Target minimum decline – The minimum price target is the distance from the tops to the neckline. However, larger declines are common.
- Account for other factors – Be aware of nearby support levels, chart patterns, or indicators that may alter your target projection.
- Scale out of winners – Consider taking partial profits on a portion of the position as the trade moves in your favor.
Trading double tops provides a great risk/reward scenario if traded properly. The risk is defined as the distance from entry to stop loss, while the initial profit target is about the same distance. It’s wise to seek at least a 1:1 risk-reward ratio.
Let’s walk through an example…
For a stock with a double top at $50 and a neckline at $40, we would:
- Wait for a close below $40 to confirm pattern.
- Enter short position with stop loss at $51.
- Target minimum $10 decline to around $30.
- Manage the trade as price moves lower.
This provides us with $1 of risk for every $1 of potential profit or better, a solid reward for the risk taken.
Tips for Trading the Double Top
Here are some additional tips for trading double tops effectively:
- Trade in the direction of the broader trend – For example, trade a double top that forms in a downtrend more readily than one in an uptrend.
- Confirm with volume – Ideal if volume increases on second top and confirmation breakdown.
- Look for divergence – Bearish divergence on indicators like RSI add confidence.
- Be patient – Wait for clear confirmation rather than anticipating.
- Use stop-loss orders – Control risk by placing stop loss orders above pattern.
- Book partial profits – Consider scaling out to lock in some gains as trade moves in your favor.
- Track win rate – Gauge your success trading various chart patterns. Double tops tend to have a high win rate.
With proper trade planning and risk management, the double top can provide high-probability setups. Pay close attention to volume patterns and be patient waiting for confirmation.
The Psychology Behind the Double Top Formation
There’s an interesting market psychology behind double top formations. Understanding what drives this pattern can improve trading insights.
The double top takes shape as follows:
First top – Euphoria among bulls as uptrend accelerates. Price peaks as buying power is exhausted.
Decline – Disbelief among bulls as buyers stay on the sidelines. Price drops and seeks support.
Second top – Renewed optimism among bulls, believing prior high will be exceeded. Insufficient buyers underpinning rally.
Breakdown – Panic sets in among bulls. Support fails as bears take control. Clear shift in psychology.
- The failed second top and support breakdown reflects a decisive turn in market sentiment from greed to fear. Bulls are forced to unwind long positions, fueling the reversal.
Understanding this psychology helps traders better identify exhausted trends and sentiment shifts as price forms important highs or lows. This knowledge improves pattern recognition and timing of entries.
Pros and Cons of Trading the Double Top
Let’s summarize the key advantages and disadvantages of trading double top patterns:
Pros:
- Clear pattern with visual shape easy to recognize
- Provides defined areas for stop loss and profit target
- Powerful and reliable reversal pattern that tends to work often
- Trades in direction of new trend after reversal confirmed
Cons:
- Requires patience to wait for confirmation before trading
- Stop loss and target are close, smaller reward/risk ratio
- Breakdown can be swift leaving little opportunity to enter
- Price doesn’t always reach target minimum projection
Overall, the double top is one of the most advantageous chart patterns to trade due to its high win rate and defined risk management parameters. However, traders need to wait for confirmation and be aware of quick breakdowns.
FAQs
Here are answers to some frequently asked questions about the double top pattern:
What’s the minimum price decline to confirm a double top?
The minimum decline is a break below the support neckline. However, 10-20% or more from the top is best to confirm a significant reversal.
How far apart can the two tops form?
Typically no more than 1-3 months. Greater spacing makes pattern less significant. Tops should form within same price range.
Does volume matter in double tops?
Ideally volume is heavier on second top and downside break. But volume alone doesn’t confirm or invalidate the pattern.
Is the double top more reliable than other patterns?
Yes, double tops tend to have a higher win rate compared to many other chart patterns. Their visual shape makes them straightforward to identify.
Do I have to short sell to trade double tops?
No. You can buy inverse ETFs or put options to benefit from the decline. But short selling provides the most direct strategy.
What if price rises after the breakdown?
Sometimes there are false breakdowns where price recovers. Use a stop loss above the second top to limit losses.
Can double tops form in forex, cryptocurrency, etc.?
Yes, double tops form across all liquid markets. The same principles apply regardless of the instrument.
Should I trade triple tops or double bottoms too?
Yes, triple tops and double bottoms are also well-known reversal patterns worth trading. The same rules generally apply.
Carefully study formation guidelines, maintain risk discipline, and stay patient for confirmation to effectively trade double top patterns.
Conclusion
The double top is a powerful reversal pattern signaling a potential shift from an uptrend to a downtrend. Its visual shape makes it straightforward to identify on the chart.
By studying the key characteristics of double tops and understanding the market psychology behind their formation, traders can better recognize these patterns and improve timing on entries and exits.
Some key tips include waiting for a clear breakdown below the neckline before entering trades, placing stop losses above the pattern, targeting a minimum decline equal to the top-to-neckline distance, and scaling out of profitable trades.
With the right knowledge and risk management strategies, double tops can provide traders high-probability setups with defined areas for both stop loss placement and profit targets. Just be sure to wait for confirmation, act patiently on signals, and manage trades effectively once in the position.
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