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Lesson 12: Double Top and Double Bottoms

Lesson 12: Double Top and Double Bottoms

It is not as easy to spot Double Top and Double Bottoms one would think because there needs to be a confirmation with a break below support or above resistance.

Double tops and double bottoms are chart patterns used to signify a reversal from the prevailing trend. Double top and double bottom formations are highly effective when identified correctly. However, they can be extremely detrimental when they are interpreted incorrectly.

How to use this guide

To get the most out of this guide, it’s recommended to practice putting these Double Top and Double Bottom trading strategies into action. The best risk-free way to test these strategies is with a demo account, which gives you access to our trading platform and $10,000 in virtual funds for you to practice with. Get your free demo account.

Once you’ve found a strategy that consistently delivers positive results, it’s time to upgrade to a fully funded live account where you can apply your newfound edge.

What is a Double Top?

A double top is a bearish chart pattern that forms after an asset reaches a high price two consecutive times with a moderate decline between the two highs. It is confirmed once the asset's price falls below a support level (neckline) and continues downwards. The double bottom looks like the letter "M".

What is a Double Top?
Source: CAPEX.com

What is a Double Bottom?

A double bottom is a bullish chart pattern that forms after an asset reaches a low price two consecutive times with a moderate decline between the two highs. It is confirmed once the asset's price breaks above a resistance level (neckline) and continues upwards. The double bottom looks like the letter "W".

What is a Double Bottom
Source: CAPEX.com

What do double tops and double bottoms tell traders?

Double Tops and Double Bottoms, as well as Triple Tops and Triple Bottoms, are all variations on the same theme:

  • A support/resistance level is tested and held, forming the first top or bottom.
  • Price retreats for a time and the farthest extent of this pullback is called the neckline.
  • Price rebounds to the support and resistance levels, which holds again, followed by another retreat, which this time, extends past the neckline for a move equidistant to the distance from the top or bottom to the neckline.
  • A third test of the support/resistance level makes this a triple top or bottom.
  • These are all reversal patterns, that is, they suggest that the current trend will reverse.
  • The key difference:
    - A double or triple top comes after an uptrend.
    - A double or triple bottom comes after a downtrend.

A double top signal the reversal of an uptrend. The tops are peaks that are formed during an uptrend, when the price hits strong resistance, bounces down, and repeats this process, forming a double top. Ideally, this resistance will be confirmed by other forms of resistance at the peaks, like a long-established price level, a Fibonacci retracement level, a long duration Moving Average, and so on. If this process repeats a third time, that’s a triple top.

A double bottom signals the reversal of an uptrend. The bottoms are lows that are formed during an uptrend, when the price hits strong resistance, bounces down, and repeats this process, forming a double top. Ideally, this resistance will be confirmed by other forms of resistance at the peaks, like a long-established price level, a Fibonacci retracement level, a long duration Moving Average, and so on. If this process repeats a third time, that’s a triple top.

The logic of these being reversal patterns is clear: If a resistance (in uptrends) or support (in downtrends) has held up through two to three tests, odds are the trend is finished, so the price will likely stay below that level until new fundamental factors favor a break.

What Does a Double Top Tell You?

Although there can be variations, the classic Double Top Reversal marks at least an intermediate term, if not long-term, change in trend from bullish to bearish. Many potential Double Top Reversals can form along the way up, but until key support is broken, a reversal cannot be confirmed. For clarification, we will look at the key points in the formation and then walk through an example.

  • Prior Trend: With any reversal pattern, there must be an existing trend to reverse. In the case of the Double Top, a significant uptrend of several months should be in place.
  • First Peak: The first peak should mark the highest point of the current trend. As such, the first peak is normal, and the uptrend is not in jeopardy (or in question) currently.
  • Trough: After the first peak, there is generally a decline of a few percents. Volume on the decline from the first peak is usually inconsequential. The lows are sometimes rounded or drawn out a bit, which can be a sign of tepid demand.
  • Second Peak: The advance off the lows usually occurs with low volume and meets resistance from the previous high. Resistance from the previous high should be expected. Even after meeting resistance, only the possibility of a Double Top exists. The pattern still needs to be confirmed. The time period between peaks can vary from a few weeks to many months, with the norm being 1-3 months. While exact peaks are preferable, there is some leeway. Usually, a peak within tens of pips of the previous high is adequate.
  • Decline from Peak: The subsequent decline from the second peak should witness an expansion in volume and/or an accelerated descent, perhaps marked with a gap or two. Such a decline shows that the forces of demand are weaker than supply and a support test is imminent.
  • Support Break: Even after trading down to support, the Double Top and trend reversal are still not complete. Breaking support from the lowest point between the peaks completes the Double Top. This too should occur with an increase in volume and/or an accelerated descent.
  • Support Turned Resistance: Broken support becomes potential resistance and there is sometimes a test of this newfound resistance level with a reaction rally. Such a test can offer a second chance to exit a position or initiate a short position.
  • Price Target: The distance from support break to peak can be subtracted from the support break for a price target. This would infer that the bigger the formation is, the larger the potential decline.

While the Double Top pattern may seem straightforward, technicians should take proper steps to avoid deceptive Double Tops. The peaks should be separated by about a month. If the peaks are too close, they could just represent normal resistance rather than a lasting change in the supply/demand picture. Ensure that the low between the peaks declines at least 3-5% in forex trading, 10% in stock trading, and 15-20% in cryptocurrency trading. Small declines may not be indicative of a significant increase in selling pressure. After the decline, analyse the trough for clues on the strength of demand. If the trough drags on a bit and has trouble moving back up, demand could be drying up. When the security does advance, look for a contraction in volume as a further indication of weakening demand.

Perhaps the most important aspect of a Double Top is to avoid jumping the gun. Wait for support to be broken in a convincing manner, and usually with an expansion of volume. A price or time filter can be applied to differentiate between valid and false support breaks. A price filter might require a consistent support break before validation. A time filter might require the support break to hold for 3 days before considering it valid. The trend is in force until proven otherwise. This applies to the Double Top pattern as well. Until support is broken in a convincing manner, the trend remains up.

What Does a Double Bottom Tell You?

Although there can be variations, the classic Double Bottom pattern usually marks an intermediate or long-term change in trend. Many potential Double Bottom patterns can form during a downtrend, but until key resistance is broken, a reversal cannot be confirmed. To help clarify, we will look at the key points in the formation and then walk through an example.

  • Prior Trend: With any reversal pattern, there must be an existing trend to reverse. In the case of the Double Bottom, a significant downtrend of several months should be in place.
  • First Trough: The first trough should mark the lowest point of the current trend. As such, the first trough is normal in appearance and the downtrend remains firmly in place.
  • Peak: After the first trough, an advance takes place that typically ranges from 3 to 5% in forex market and from 10 to 20% in stock markets. Volume on the advance from the first trough is usually inconsequential, but an increase could signal early accumulation. The height of the peak is sometimes rounded or drawn out a bit from the hesitation to go back down. This hesitation indicates that demand is increasing, but still not strong enough for a breakout.
  • Second Trough: The decline off of the reaction high usually occurs with low volume and meets support from the previous low. Support from the previous low should be expected. Even after establishing support, only the possibility of a Double Bottom Reversal exists, and it still needs to be confirmed. The time period between troughs can vary from a few weeks to many months, with the norm being 1-3 months. While exact troughs are preferable, there is some room to maneuver; typically, a trough within 0.5% in FX and 3% in stocks of its predecessor is considered valid.
  • Advance From Trough: Volume is more important for the Double Bottom Reversal than the double top. There should be clear evidence that volume and buying pressure are accelerating during the advance off of the second trough. An accelerated ascent, perhaps marked with a gap or two, also indicates a potential change in sentiment.
  • Resistance Break: Even after trading up to resistance, the double top and trend reversal are still not complete. Breaking resistance from the highest point between the troughs completes the Double Bottom Reversal. Like advances, these should occur with an increase in volume and/or an accelerated ascent.
  • Resistance Turned Support: Broken resistance becomes potential support and there is sometimes a test of this newfound support level with the first correction. Such a test can offer a second chance to close a short position or initiate a long position.
  • Price Target: The distance from the resistance breakout to trough lows can be added on top of the resistance break to estimate a target. This would imply that the bigger the formation is, the larger the potential advance.

It is important to remember that the Double Bottom is an intermediate to long-term reversal pattern that will not form in a few days. Even though formation in a few weeks is possible, it is preferable to have at least 4 weeks between lows. Bottoms usually take longer to form than tops; patience can often be a virtue. Give the pattern time to develop and look for the proper clues. The advance off of the first trough should be 3-5% in FX and 10-20% in stocks. The second trough should form a low within 0.5% in FX and 3% in stocks of the previous low and volume on the ensuing advance should increase. Volume indicators such as Chaikin Money Flow, OBV and Accumulation/Distribution can be used to look for signs of buying pressure. Just as with the double top, it is paramount to wait for the resistance breakout. The formation is not complete until the previous reaction high is taken out.

How to trade on double tops and double bottoms

There are two ways to trade using the double top and double bottom patterns: you’d open a short position on a double top, and a long position on a double bottom. Before you do either, however, it is important to confirm the signal with other technical indicators such as the elative strength index (RSI) or the parabolic SAR – both of which are momentum indicators.

When you see the double top and double bottom patterns and you want to place a trade, you can do so via derivatives such as CFDs. Derivatives enable you to trade rising as well as declining prices. So, depending on what you think will happen with the asset’s price when one of the double top or double bottom patterns appears, you can open a long position or a short position.

Follow these steps to trade when you see the double top and double bottom patterns:

  • Trading any type of chart patterns requires patience and the ability to wait for confirmation. The appearance of one of these patterns alerts traders of a price reversal, but until that occurs, most traders leave the pattern alone.
  • To get started trading double top and double bottom patterns, open an account. Choose between a live account to trade CFDs straight away or practise first on our demo account with virtual funds.
  • Choose your financial instrument. Double top and double bottom patterns can be spotted in most financial markets, especially those that are more volatile, such as forex, cryptocurrencies, and stocks.
  • Explore our online trading platform. We offer a wide range of technical indicators used to filter and confirm double top and double bottom patterns, as well as providing a range of order execution tools for fast trading, which in turn helps you to manage risk.

The below strategies for trading double top and double bottom patterns are merely guidance and cannot be relied on for profit.

Double top trading example

How to Trade the Downtrend Following a Bearish Double Top Pattern

As an example of a double-top trade, let’s look at the price graph below. As you can see, the trend before the first peak is overall bullish, indicating a market that is rising in value. However, the upward momentum stops at the first peak and retraces down to the neckline.

At this point, if the momentum had continued lower, the pattern would have been void. But, it bounced off the neckline and resumed the bullish trend. This continued only for a short while before the asset once again lost its momentum. This time, the retracement broke through the neckline which signified a more permanent reversal in the overall momentum of the asset’s value.

In this scenario, there are 2 methods, that can be used separately or with the same trade by adding to the initial position:

  • A trader would try to open a short position at the height of the second peak – before the pattern had been fully confirmed. They would likely exit their short position at an early sign that the trend was once again turning bullish.

Traders can use stop orders to protect themselves from sustaining a loss in case the market continues to rise after the second peak. You can learn more about risk management with CAPEX Academy.

  • When price falls below the neckline (the lowest closing price between the two tops), that is a confirmation of the reversal. So, that’s the area where you would place your sell limit order to open a short position because you’d be anticipating a new move lower, typically about the same distance again as the distance from the peaks to the neckline, as illustrated below. The same rules apply for a triple top.

Traders can use stop orders to protect themselves from sustaining a loss in case the market resumes the uptrend after the temporary fall below the neckline (fake breakout)

Double top trading

Double bottom trading example

How to Trade the Uptrend Following a Bullish Double Bottom Pattern

As an example of a double-bottom trade, let’s use the price graph below. As it shows, the trend before the double bottom pattern was bearish, indicating this market was falling in value. In this pattern, the downward momentum stops at the first low and retraces up to the neckline.

At this point, if the momentum had continued higher the pattern would have been void. Instead, it bounced off the neckline and resumed the overall bearish trend before the first low. That momentum eventually stopped, and the second low was formed. Here, the trend experienced a more permanent reversal and continued up through the level of resistance as the neckline.

In this scenario, there are 2 methods, that can be used separately or with the same trade by adding to the initial position:

  • A trader would try to open a long position at the second low. They would likely exit their long position at an early sign of reversal in the prevailing trend, at which point it would once again turn bearish.

As with a double top pattern, traders can use stop-loss orders when trading the double bottom pattern in order to protect themselves from sustaining a loss in case the market continues to fall after the second low. To “lock” some profits traders can use a trailing stop order, available on most of the trading platforms today.

  • In the chart below, the farthest pullback from support forms the neckline, which is where we place an entry buy limit order to open a long position, with a profit target of twice the distance in pips from the double bottoms to the neckline. In practice, we would consider this trade if it fits with our risk management rules.

Here’s a sneak preview of those rules. We’d consider taking this trade if we believed:

  1. The distance in pips from the neckline to our profit-taking target was about three times the distance from the neckline to our stop loss.
  2. The neckline provided solid enough support to place that stop loss order far enough beneath it to avoid getting hit by random price movements.

Double bottoms, like double tops, are trend reversal patterns. You’ll want to look for these after a strong downtrend and wait until the price reverses above the neckline (the farthest point of the bounce-off support) as likely confirmation of the reversal.

The above applies to triple bottoms, too. They include a third test of the same support level.

Traders can use stop orders to limit the loss in case the market resumes the downtrend after a temporary advance above the neckline (fake breakout).

Double bottom trading

Beware False Breakouts, Shake Outs, and Other Fake Outs

False breakouts often occur at widely anticipated breakout points like the neckline of a double or triple bottom. Vast flocks of inexperienced traders will attempt to go long at these points. So, big, experienced players may attempt to use these breakout points to fool you into selling too early near the bottom or buying too late near the top.

For example, the neckline of a double or triple bottom will attract a lot of buy orders from traders attempting to buy just as the widely anticipated breakout higher begins. As it starts, big players may join the buying to briefly pump up the price and lure in more buyers. They may then attempt to drive the price back down with some large sell orders (taking a quick profit on those new long positions and opening new short positions) so that enough stop loss orders get hit to start a wave of selling that drives the price down further as the selling “shakes out” more long positions. That is a basic “false breakout.”

The experienced traders are now sitting with large short positions they accumulated in creating the mini sell-off. The pair is now lower, so they take profits on these shorts by buying back the pair at a lower price from inexperienced retail traders. Ideally, that buying lures in enough others to get the price back past the neckline and start the real breakout, which pros may feed by taking more long positions, perhaps attracting more buyers and driving the price higher. At some point, they then take profits on these long positions, and so on.

That’s why you might use stop losses. It’s why you might wait to enter until the break past the neckline is a bit more advanced (at a cost of getting in later on the move up and losing some profit), and you might wait until the price has made a false breakout pullback and has resumed its break past the neckline. In addition, you could get other kinds of confirmation of the reversal.

Double tops and double bottoms in trading summed up

Both double top and bottom patterns can be used in trading to provide entry points, as well as stop-loss and profit target locations. The stop-loss helps to control the risk of the trade.

Summary

  • Double tops and double bottoms are trend reversal patterns.
  • They are used to determine whether a bearish trend is turning bullish, or whether a bullish trend is turning bearish.
  • Traders will open a short position at the height of the second peak of a double top and/or after a support breakout confirmation.
  • Traders will open a long position at the level of the second low of a double bottom and/or after a resistance breakout confirmation.
  • The pattern is only confirmed once the trendline has broken through the neckline, if it does not then either pattern is void.

Free trading tools and resources

Remember, you should have some trading experience and knowledge before you decide to trade chart patterns. You should consider using the educational resources we offer likeCAPEX Academyor ademo trading account. CAPEX Academy has lots of courses for you to choose from, and they all tackle a different financial concept or process – like the basics of analyses – to help you to become a better trader.

Our demo account is a great place for you to learn more about leveraged trading, and you’ll be able to get an intimate understanding of how CFDs work – as well as what it’s like to trade with leverage – before risking real capital. For this reason, a demo account with us is a great tool for investors who are looking to make a transition to leveraged trading.

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