No chart pattern is more common in trading than the double bottom or double top. In fact, this pattern appears so often that it alone may serve as proof positive that price action is not as wildly random as many academics claim. Price charts simply express trader sentiment and double tops and double bottoms represent a retesting of temporary extremes. If prices were truly random, why do they pause so frequently at just those points? To traders, the answer is that many participants are making their stand at those clearly demarcated levels.

SEE: Using Double Tops And Double Bottoms In Currency Trading

If these levels undergo and repel attacks, they instill even more confidence in the traders who've defended the barrier and, as such, are likely to generate strong profitable countermoves. Here we look at the difficult task of spotting the important double bottom and double tops, and we demonstrate how Bollinger Bands® can help you set appropriate stops when you're trading these patterns.

An example of a double top in EUR/USD forming as longs.
Chart Created by Intellichart from
A very tight double bottom leads to a 150 point explosion.
Chart Created by Intellichart from

React or Anticipate?
One great criticism of technical pattern trading is that setups always look obvious in hindsight but that executing in real time is actually very difficult. Double tops and double bottoms are no exception. Although these patterns appear almost daily, successfully identifying and trading the patterns is no easy task.

SEE: A Trader's Guide To Using Fractals

There are two approaches to this problem and both have their merits and drawbacks. In short, traders can either anticipate these formations or wait for confirmation and react to them. Which approach you chose is more a function of your personality than relative merit. Those who have a fader mentality - who love to fight the tape, sell into strength and buy weakness - will try to anticipate the pattern by stepping in front of the price move.

Anticipatory trader will set an entry zone.
Chart Created by Intellichart from
The strategy works if the trader is able to obtain an excellent entry.
Chart Created by Intellichart from
The strategy runs the risk of failing.
Chart Created by Intellichart from

Reactive traders, who want to see confirmation of the pattern before entering, have the advantage of knowing that the pattern exists but there's a tradeoff: they must pay worse prices and suffer greater losses should the pattern fail.

Patience has viture for the reactive trader.
Chart Created by Intellichart from
Waiting for confirmation will often leave the trader buying the top.
Chart Created by Intellichart from

What's Obvious Is Not Often Right
Most traders are inclined to place a stop right at the bottom of a double bottom or top of the double top. The conventional wisdom says that once the pattern is broken, the trader should get out. But conventional wisdom is often wrong.

Leaving the trade early may seem prudent and logical, but markets are rarely that straightforward. Many retail traders play double tops/bottoms, and, knowing this, dealers and institutional traders love to exploit the retail traders' behavior of exiting early, forcing the weak hands out of the trade before price changes direction. The net effect is a series of frustrating stops out of positions that often would have turned out to be successful trades.

SEE: Introduction To Institutional Investing

A stop here is a big mistake.
Chart Created by Intellichart from

What Are Stops For?
Most traders make the mistake of using stops for risk control. But risk control in trading should be achieved through proper position size, not stops. The general rule of thumb is never to risk more than 2% of capital per trade. For smaller traders, that can sometimes mean ridiculously small trades.

Fortunately in FX where many dealers allow flexible lot sizes, down to one unit per lot - the 2% rule of thumb is easily possible. Nevertheless, many traders insist on using tight stops on highly leveraged positions. In fact, it is quite common for a trader to generate 10 consecutive losing trades under such tight stop methods. So, we could say that in FX, instead of controlling risk, ineffective stops might even increase it. Their function, then, is to determine the highest probability for a point of failure. An effective stop poses little doubt to the trader over whether he or she is wrong.

Implementing the True Function of Stops
A technique using Bollinger Bands can help traders set those proper stops. Because Bollinger Bands® incorporate volatility by using standard deviations in their calculations, they can accurately project price levels at which traders should abandon their trades.

The method for using Bollinger-Bands stops for double tops and double bottoms is quite simple:

  1. Isolate the point of the first top or bottom, and overlay Bollinger Bands with four standard-deviation parameters.
  2. Draw a line from the first top or bottom to the Bollinger Band. The point of intersection becomes your stop.

At first glance four standard deviations may seem like an extreme choice. After all, two standard deviations cover 95% of possible scenarios in a normal distribution of a dataset. However, all those who have traded financial markets know that price action is anything but normal - if it were, the type of crashes that happen in financial markets every five or 10 years would occur only once every 6,000 years. Classic statistical assumptions are not very useful for traders. Therefore setting a wider standard-deviation parameter is a must.

SEE: Using Bollinger Band® "Bands" To Gauge Trends

The four standard deviations cover more than 99% of all probabilities and therefore seem to offer a reasonable cut-off point. More importantly they work well in actual testing, providing stops that are not too tight, yet not so wide as to become prohibitively costly. Note how well they work on the following GBP/USD example.

An anticipatory trader can survive.
Chart Created by Intellichart from

More importantly, take a look at the next example. A true sign of a proper stop is a capacity to protect the trader from runaway losses. In the following chart, the trade is clearly wrong but is stopped out well before the one-way move causes major damage to the trader's account.

This is clearly wrong but is stopped out well before there are damages.
Chart Created by Intellichart from

The Bottom Line
The genius of Bollinger Bands is their adaptability. By constantly incorporating volatility, they adjust quickly to the rhythm of the market. Using them to set proper stops when trading double bottoms and double tops - the most frequent price patterns in FX - makes those common trades much more effective.

Related Articles
  1. Home & Auto

    Leveraging Leverage For Bigger Profits

    Leverage is like fire. Find out how to use it to heat up your investing without burning your portfolio.
  2. Forex Education

    5 Forex Day Trading Mistakes To Avoid

    We will look at five common mistakes that day traders often make in an attempt to ramp up returns.
  3. Forex Education

    Most Commonly Used Forex Chart Patterns

    These chart patterns provide entries, stops and profit targets that can be easily seen.
  4. Options & Futures

    What Is Your Risk Tolerance?

    Forget the cliches and uncover how much volatility you can really stand.
  5. Options & Futures

    Stop Hunting With The Big Forex Players

    Learn to bank short-term profits by placing stops away from the crowd.
  6. Technical Indicators

    Using Pivot Points For Predictions

    Learn one of the most common methods of finding support and resistance levels.
  7. Chart Advisor

    ChartAdvisor for November 20 2015

    Weekly technical summary of the major U.S. indexes.
  8. Chart Advisor

    Is This The Beginning Of A Downtrend In Home Builders?

    Falling lumber prices and weakness on the charts of home builders suggest that the next leg of the trend could be downward.
  9. Forex Education

    9 Tricks Of The Successful Forex Trader

    These steps will make you a more disciplined, smarter and, ultimately, wealthier trader.
  10. Forex Strategies

    3 Simple Strategies For Euro Traders

    Euro traders can execute three simple but effective strategies that take advantage of repeating price action.
  1. What are the main differences between a double top and a double bottom?

    Fluctuating prices over time tend to cause patterns easily identifiable on a chart. Two of the most commonly seen patterns ... Read Full Answer >>
  2. What are common trading strategies used when identifying a double bottom

    A double bottom is formed when price falls to a new low, retraces upward some distance, turns back to the downside and stops ... Read Full Answer >>
  3. How effective are double tops in spotting a change in the overall trend?

    Double tops and double bottoms are two of the most commonly appearing stock price chart patterns. Traders use them to identify ... Read Full Answer >>
  4. What are some of the most common technical indicators that back up Doji patterns?

    The doji candlestick is important enough that Steve Nison devotes an entire chapter to it in his definitive work on candlestick ... Read Full Answer >>
  5. Tame Panic Selling with the Exhausted Selling Model

    The exhausted selling model is a pricing strategy used to identify and trade based off of the price floor of a security. ... Read Full Answer >>
  6. Point and Figure Charting Using Count Analysis

    Count analysis is a means of interpreting point and figure charts to measure vertical price movements. Technical analysts ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  2. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  3. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
  4. Black Monday

    October 19, 1987, when the Dow Jones Industrial Average (DJIA) lost almost 22% in a single day. That event marked the beginning ...
  5. Monetary Policy

    Monetary policy is the actions of a central bank, currency board or other regulatory committee that determine the size and ...
  6. Indemnity

    Indemnity is compensation for damages or loss. Indemnity in the legal sense may also refer to an exemption from liability ...
Trading Center