The Double Top Pattern Explained
The double top pattern is one of the most common and reliable chart patterns in technical analysis.
In this article, we will explain what the double top pattern is, how to trade it, and how to identify it easily on a chart.
What is the Double Top Chart Pattern?
The double top chart pattern is a bearish reversal pattern that forms after an asset reaches a high price two consecutive times with a moderate decline between the two highs.
The pattern is validated when the price drops below a support level that matches the low point between the two previous highs. The pattern resembles the letter “M” and indicates that the buyers are losing momentum and the sellers are taking control.
The double top pattern consists of four main elements:
The first peak: This is the first high price that the asset reaches after an uptrend. It represents a strong resistance level where the buyers face selling pressure and the price starts to decline.
The trough: This is the low price that the asset reaches after the first peak. It represents a temporary support level where the buyers regain some strength and push the price up again.
The second peak: This is the second high price that the asset reaches after the trough. It is usually slightly lower than or equal to the first peak, indicating that the buyers are losing steam and the sellers are gaining ground.
The neckline: This is the horizontal line that connects the low points of the trough and extends to the right. It represents a critical support level that confirms the pattern once it is broken by the price.
Is the Double Top Pattern Bullish or Bearish?
The double top pattern is a bearish reversal pattern, meaning that it signals a possible change in the direction of the trend from up to down. The pattern shows that the buyers are failing to push the price higher and that the sellers are taking over.
Once the price breaks below the neckline, it indicates that the downtrend has begun and that further declines are likely. However, if the price bounces from the neckline, it can potentially form a triple top pattern.
How to Trade the Double Top Pattern?
To trade this pattern, you need to look for an asset that has formed two relatively similar peaks and find the neckline. Once the price breaks through the neckline with a decisive candlestick, you can then enter the market with a sell order.
The stop loss is placed above the double top resistance, which is the highest point of either peak. The profit target is measured by taking the height of the pattern between the neckline and double top resistance and projecting it downward from the breakout point.
For example, if the height of the pattern is $1, you can set a profit target of $1 below your entry point.
Double Top Pattern Stock Chart Example
The example we will use is on ROL stock. The first peak was formed on September 18, 2018, at $28.62. The neckline was around $24.50. The second peak was formed on October 1, 2018, at $28.63. It then broke below the neckline on December 13, 2018, with a strong bearish candlestick.
As you can see from the chart above, ROL stock formed a clear double top pattern between September and December 2018. The price broke below the neckline at $24.50 and continued lower. While this example didn’t completely reach the profit target, there were several opportunities to take profit or set a stop-loss in a guaranteed profit.
How to Identify the Double Top Pattern?
As you identify double top formations, consider these key elements:
Uptrend: The price should be clearly going up before the pattern emerges, as shown by higher peaks and higher troughs. Two highs: The pattern has two highs that are roughly similar in price. They should not be too distant or too near to each other.
Two peaks: The price should be evidently rising before the pattern appears, as indicated by higher tops and higher bottoms. Two crests: The pattern contains two crests that are approximately equal in price. They should not be too separated or too close to one another.
Neckline: The neckline should be horizontal or slightly tilted downward. It should not be too steep or too flat.
Volume: The volume should decrease as the price approaches the second peak, indicating a lack of buying interest. The volume should increase as the price breaks below the neckline, indicating a surge of selling pressure.
The Double Top Pattern | Bottom Line
The double top pattern can help you spot potential trend reversals and profit from them by selling short or exiting long positions. However, you should always use other indicators and confirmations to validate your trading signals and manage your risk.
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Frequently Asked Questions
Q: What will happen after double top pattern?
A: A double top pattern is a bearish reversal pattern that signals the end of an uptrend and the start of a downtrend. After a double top pattern is confirmed, the price is likely to continue falling below the neckline, which is the support level between the two peaks.
Q: What is the best time frame for a double top pattern?
A: A double top pattern can occur on any time frame, but it is more reliable and significant on higher time frames, such as daily, weekly, or monthly charts. The higher the time frame, the more confirmation and volume are required for the pattern to be valid. The time period between the peaks can vary from a few weeks to several months, with the norm being 1-3 months.
Q: What invalidates a double top?
A: A double top is invalidated if the price does not break below the neckline or if it breaks above the resistance level of the two peaks. If the price does not break below the neckline, it means that the buyers are still in control, and the uptrend may resume. If the price breaks above the resistance level, it means that the sellers are exhausted, and the buyers have pushed the price to a new high.
Q: Does a double top have to be perfect?
A: No, a double top does not have to be perfect. The two peaks do not have to be exactly equal in price or time. However, they should be close enough to show that the price has reached a similar resistance level twice and failed to break through.
Q: What is the target of double top?
A: The target of the double top is based on the height of the pattern, which is measured by the distance between the neckline and the highest point of either peak. The target is then projected downward from the breakout point below the neckline. For example, if the height of the pattern is $10, then the target is $10 below the breakout point.
