It is widely believed that you have to invest for a long time to grow your wealth through equity markets. While long-term investments have their benefits, it is not the only way to be financially successful. Trading can be rewarding with proper knowledge, research and risk management strategies. To trade successfully, you need to spot different patterns and keep a keen eye on them to understand their meaning. While most patterns are specific to candlestick charts, double top patterns can be found in line charts and bar charts in addition to candlestick charts.
Construction
A pattern in itself may not be helpful if you don’t have any idea of the action to take. Patterns can be broadly classified into two patterns, continuation patterns and reversal patterns. The Double Top chart pattern is a strong bearish reversal pattern. This signals the end of a long rally. As the name suggests, a double top chart has two highs and a low in between them. The double top pattern is confirmed once the price falls below the support level after the second top. The support level is the lowest between the two tops.
Meaning of Double Top Pattern
The formation of the Double Top pattern is easy to spot on technical charts. However, the Double Top pattern is one of the most misunderstood patterns. The double top pattern should be confirmed after the formation of the second top. Let us understand the meaning of Double Top to get a clear idea of what we should do if we find such a pattern.
The formation of a top is clearly a sign of bulls taking control of the market. Bulls drive the price to the top which is followed by a typical correction. The correct result is obtained in the minimum between the two tops. After the decline, the bulls take control and push the price higher creating a second top. The pattern becomes interesting after the second top is constructed. One important thing to note in case of double top chart is that the high of the second top is almost equal to the high of the first top, which indicates close dominance of the bulls.
How to do business?
The formation of the second top is an inflexion point for the double top pattern. After the formation of the second top there can be two possibilities. If the bulls are able to regain control and do not allow the price to fall below the support level, the double top pattern does not form.
However, if the bears dominate and the price drops below the support level, which is the level during the low between the two tops, the double top pattern is confirmed. This is a sign of extreme reversal and then one should ideally short the security.
When taking action based on the formation of a double top, it is important to keep a few factors in mind.
Broad Trend: The formation of a double top is a bearish reversal trend. It is only effective if it is formed following a broader uptrend. Before a double top is formed, the uptrend must be in place for a long period of time, at least three months. A double top pattern should be avoided after a short rally.
Height: A double top construction should have a different height and depth. There is no parameter to well define the height or depth of the double top pattern, although a difference of 10% is desirable. The double top pattern with deep lows is considered a strong signal of reversal. But creating deeper patterns may take more time.
Width: If the time difference between the formation of a top, also called width, is wide enough, the top can be easily identified. While the gap between two tops may be a few months or years, there should be a minimum gap of one month.
Volume: Trading volume is one of the strongest signals that confirms the formation of a pattern. The volume of the second top is usually less than the first top. If the volume of the second top is equal to or greater than that of the first top, the reversal cannot continue and the rally may continue.
