A Logical Guide to Mastering Double Top and Double Bottom Patterns for Effective Trading

 

Discover the secrets of Double Top and Double Bottom patterns in technical analysis. Our logical guide provides step-by- step identification, trading strategies, nuggets, and tips to enhance your trading success.

Table of contents:

•  Introduction
•  Understanding Double Top and Double Bottom Patterns
•  Identifying Double Top Patterns
•  Identifying Double Bottom Patterns
•  Trading Strategies for Double Top
•  Trading Strategies for Double Bottom
•  Enhancing Patterns recognition with Tools and Indicators
•  Conclusion

Introduction:

In technical analysis we use candlesticks patterns to anticipate future price movements of stocks or assets. There are various types of candlesticks patterns which we have already discussed in our previous blog posts "A Logical guide to Candlestickspatterns" part 1,2,3.

 

Like in candlesticks, there are also some important patterns in Dow Theory which are integral parts of technical analysis. Some of the important patterns in Dow Theory are:

1. The Double Top and Double Bottom Patterns

 

2. The Triple Top and Triple Bottom

 

3. Flag and Pole Patterns

 

4. Range Patterns

 

5. Support and Resistance. 

 

In this article we are going to discuss in details about Double Top and Double Bottom patterns. 

 

 Understanding the Double Top and Double Bottom Patterns: 

 

The Double Top and Double Bottom chart patterns are considered reversal patterns. Reversal patterns are those patterns that indicate a change or reversal in trend. 

Double Top Pattern:

 

It is a bearish reversal pattern that typically occurs after an extended uptrend in price of a stock or an asset. It is a common chart pattern we observe in financial markets very often indicating potential reversal of an uptrend. It looks like the letter "M" when the pattern is formed. So we call this pattern as M pattern. It can happen in any time frame in 15 minutes, in hourly, in daily, in weekly or in fact, in monthly also. 

Double Bottom Pattern:

 

It is a bullish reversal pattern that typically occurs after the end of a downtrend. It is completely opposite of Double Top pattern. It looks like the letter "W" when the pattern is formed. So we call this pattern as W pattern. This pattern can happen in any time frame 15 minutes, 30 minutes, hourly, daily, weekly or in fact, in monthly also. 

 

 Identifying Double Top Pattern:

 

It consists of the two consecutive highs or tops at the same price levels or slightly different levels separated by a trough in between taking the shape of "M"

 

The pattern formation confirmed when the price breaks through the support line which is the neckline between the two tops. And the price will continue its downtrend. During the breakdown of the neckline the volume should increase which is the proof of confirmation of the pattern. 

 Identifying Double Bottom Pattern:

 

This Pattern consists of two consecutive troughs or lows in the chart, with a high point in between. The lows should be nearly at the same levels or slightly different levels looks like "W". The pattern formation is confirmed after identifying the Double Bottom pattern, when the price breaks through the resistance or neckline above the peak that separates the two lows. The break out should be accompanied by increased volume which indicates strong buying pressure at the level. 

 

 Trading strategies for Double Top Patterns:

 

First logical guide to trading double top patterns is to wait for confirmation to form the second top. Once the second top is formed, traders should look for a bearish candle forming at the resistance. Traders can take short (sell) trade below the low of the bearish candle keeping stop loss above the high of the bearish candle. Target should be at the neckline or can trail profit if the price breaks down the neckline.

 

Another strategy is to wait for the confirmation of the complete "M" pattern to form and price breaks down the neckline with increased volume for additional confirmation. Traders can short (sell) below the neckline and keep stop-loss above the high of the neckline. Target should be the height or distance of the "M" pattern.  See the above chart for easier understanding. 

 

In the above chart of TCS in weekly it has made a double top pattern. After making the 2nd top it has made a big bearish candle at resistance. As per our 1st strategy, we can sell the stock below the bearish candle at about Rs.3810 level. See, how nicely it has gave a good down move to Rs.3400 level just at the neckline which was our target. Then it broken the neckline of Rs.3400 and gave a good down move to Rs.3000.We can sell below the neckline as per our 2nd strategy and easily achieve the target of the distance of the pattern. 

 

The 1st strategy in which we sold at the resistance is an example of selling at resistance. In the 2nd strategy, where we sold below the low of the neckline is an example of selling at break down (of support). 

Here, both the strategies have good risk reward and stop-loss is very low and profit target is high if anyone perfectly catch the patterns and utilize them perfectly with logical set up of his mindset or psychology. 

 

 Trading strategies for double bottom patterns:

First logical guide to trading double bottom patterns is to wait for the confirmation to form the second bottom. Once the second bottom is formed at the support level, traders should look for a bullish signal by forming any bullish candle at that level. Traders can take a long(buy) trade above the high of the bullish candle keeping a stop-loss below the candle's low. Target would be the neckline or they can trail their profit looking for  breaking out of the neckline. 

 

Another strategy would be to wait for the breaking out of the neckline after forming the second bottom to make a "W" shape with increased volume. Traders immediately can go for long(buy) trade above the neckline keeping a stop-loss below the second low or as per their risk appetite. See the above chart for easier understanding. 

 

Here, both the strategies have good risk reward and stop-loss is very low, and profit target is high, if anyone perfectly catch the patterns and utilize them perfectly with logical set up of his mindset or psychology. 

In the above weekly chart of Hero Motorcorp Ltd., it has made a double bottom pattern. After making the 2nd bottom a bullish candle has formed at around Rs.2200 level, which is the support zone. As per our 1st strategy, we can go long (buy) above the bullish candle's high keeping a stop-loss below the candle's low. We can see that how nicely the stock gave a move upto Rs.2900 level (neckline). 

 

 

When it formed the double bottom pattern, then it broke out of the neckline see what a beautiful upward move it has given upto Rs.4950 level, more than the height of the pattern. 

 

 

The 1st strategy in which we bought at support level is an example of buying at support. And the next strategy, where we bought at break out of the neckline is an example of buying at break out or breakout trading. 

 

 Enhancing pattern Recognition with Tools and Indicators:

By leveraging technical analysis tools and indicators can help traders to identify these patterns accurately and confidently. 

 

Moving Averages:  These can indicate perfect trend reversals when moving averages crossover happens. 

 

 

RSI:  Relative Strength Index or RSI can help to anticipate the momentum of the market, signaling a potential reversal when the market is overbought or oversold. RSI divergence can help to identify probable price reversal. 

 

 

Volume:  Also help to guess the potential reversal in the market. As an example, when the double top patterns are formed, then we should monitor the volume on the two tops. On the 1st top volume would be small but on the 2nd top volume would be higher. These are the additional confirmation of these patterns. 

 

 

So, these tools and indicators like moving averages, RSI, MACD, Volume, Bollinger Bands etc. are important tools to recognize accurately double top and double bottom patterns. 

 

 

 Conclusion:

 

Mastering double top and double bottom patterns can significantly enhance your trading strategy, providing you with reliable signals for market reversals. By understanding these patterns, employing strategic trading methods, and recognizing these double top and double bottom patterns with tools and indicators, you can increase your chances of successful trading. Keep learning and practicing to refine your skills, and soon you'll be navigating the markets with confidence and precision.

 

 

Frequently Asked Questions (FAQs):

 

1. What is the rule for Double Top and Double Bottom?

Double Tops and Double Bottoms are important patterns in Technical Analysis used by traders to anticipate trend reversals. Double Top looks like the letter "M" which indicates a trend reversal after an extended uptrend.

A Double bottom looks like the letter "W" which indicates a trend reversal after a down trend to upward trend.

 

2. What is the rate of success of Double Top and Double Bottom Patterns?

 

Double top and double bottom patterns are observed frequently in financial markets and are very reliable patterns. These patterns have more than 75% success rate.

 

3. How many candles would be in between two tops and two bottoms to make powerful double top and double bottom patterns?

 

There should be 15 to 20 candles in between two tops or two bottoms to form powerful double top and double bottom patterns. More candles in the pattern indicate more powerful it is. If the pattern is formed in 1 hour chart, there should be 15 to 20 hourly candles, if it is formed in daily chart, then there should be 15 to 20 daily candles, if it is formed in weekly chart, then there should be 15 to 20 weekly candles and so on.

 

 

4. How many M patterns and W patterns are there in the stock market?

 

As per Jhon Bollinger there are 16 types of M patterns and W patterns we see in the stock market.

 

 

Disclaimer: The information provided on MoneyWiseMind is for educational and informational purposes only. It is not intended to be financial advice, and you should not rely on it as such. Before making any financial decisions, you should consult a licensed financial advisor.

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