Forex Walkthrough

AAA

Level 4 Charts - Double Tops And Double Bottoms

One of the most common chart patterns in trading is the double bottom and double top. In fact this pattern appears so frequently that it alone could serve as evidence that price action is not as wildly random as many academics claim. One way to think of price charts is simply that they express the sum of trader sentiment, and double tops and double bottoms in particular represent a re-testing of temporary highs and lows.

Double Top
Double tops are commonly found during an uptrend in prices where a new high is formed followed by a slight pullback and a retest of the new high, but ultimately failing to surpass the price level established at the first peak. This results in a movement of prices to a lower level and completes the pattern of the double top. The second peak does not have to stop exactly at the price reached from the first peak but should be relatively close. This pattern is usually indicative of a trend that is weakening where buying interest is decreasing.

Double Bottom
A double bottom is simply the opposite of a double top. This pattern occurs during a downtrend and is a signal of a reversal of the downtrend into an uptrend. This pattern is easily recognizable after the fact by its resemblance to the letter "W". The initial downward move will find a support at the first bottom and then the price action will rally off the support to a temporary new high (the middle of the "W"). Another selloff will take place that will reach the same support level of the first bottom, and consequently cause another rally upwards. Lastly, the trend is confirmed when the price breaks through the upper resistance to complete the pattern and reversal.

Identifying The Pattern
Here we'll look at the task of spotting the important double bottoms and double tops. Take a look at the first chart of the EUR/USD for an example of a double top, and the second chart for an example of a double bottom.



Chart Created by Intellichart from FXtrek.com.



Chart Created by Intellichart from FXtrek.com.

React Or Anticipate?
One criticism of technical analysis based on chart patterns is that setups always look obvious in hindsight but anticipating them as they're occurring in real time is particularly difficult. Double tops and double bottoms are no exception. Though these patterns appear frequently, successfully identifying and trading a majority of them is no simple feat.

Anticipate
There are two approaches to this problem and both have their pros and cons. In short, traders can either try to anticipate these formations, or wait for confirmation of the pattern and then react to them. The approach you choose is more an indication of your personality or trading style than relative merit. Those who have a fader mentality - who love to fight the tape, sell into strength and buy weakness - might try to anticipate the pattern by stepping in front of the price move. See the next few charts for an example of an anticipatory trade.



Chart Created by Intellichart from FXtrek.com.



Chart Created by Intellichart from FXtrek.com.



Chart Created by Intellichart from FXtrek.com.


React
On the other hand, reactive traders, who want to see evidence or confirmation of the pattern before entering, have the advantage of knowing that the pattern exists but there's a tradeoff: their entry point is later than an anticipatory trader which results in worse prices and greater losses should the pattern fail.


Chart Created by Intellichart from FXtrek.com.



Chart Created by Intellichart from FXtrek.com.

Double tops and double bottoms are common reversal patterns every trader should keep an eye out for, as they can signal a reverse in the trend. In the next section, we're going to take a look at one of the more popular technical indicators - Bollinger Bands® - and see how they can be used to gauge trends and help traders enter and exit trades.

Bollinger Bands®
Related Articles
  1. Forex Education

    5 Foreign Currencies Americans Buy the Most

    Look at which currencies Americans buy the most for travel abroad and remittances, and how the current strength of the dollar is impacting those transactions.
  2. Investing Basics

    Contingent Convertible Bonds: Bumpy Ride Ahead

    European banks' CoCos are in crisis. What investors who hold these high-reward but high-risk bonds should know.
  3. Your Practice

    What the Next Decade Holds for Financial Advisors

    A look at the top trends of the financial advisory business in the next decade.
  4. Mutual Funds & ETFs

    The 3 Best T. Rowe Price Funds for Value Investors in 2016

    Read analyses of the top three T. Rowe Price value funds open to new investors, and learn about their investment objectives and historical performances.
  5. Active Trading Fundamentals

    4 Stocks With Bullish Head and Shoulders Patterns for 2016 (PG, ETR)

    Discover analyses of the top four stocks with bullish head and shoulders patterns forming in 2016, and learn the prices at which they should be considered.
  6. Stock Analysis

    Performance Review: Emerging Markets Equities in 2015

    Find out why emerging markets struggled in 2015 and why a half-decade long trend of poor returns is proving optimistic growth investors wrong.
  7. Investing

    Don't Freak Out Over Black Swans; Be Prepared

    Could 2016 be a big year for black swans? Who knows? Here's what black swans are, how they can devastate the unprepared, and how the prepared can emerge unscathed.
  8. Investing News

    Today's Sell-off: Are We in a Margin Liquidation?

    If we're in market liquidation, is it good news or bad news? That party depends on your timeframe.
  9. Chart Advisor

    Uptrending Stocks Dwindle, a Few Remain (EW, WEC, WR)

    The number of uptrending stocks is shrinking, but here a few that remain in uptrends.
  10. Chart Advisor

    Trade Setups Based on Descending Trend Channels (LBTYK, RRC)

    These descending trend channels have provided reliable sell signals in the past, and are giving the signal again.
RELATED TERMS
  1. Collateralized Mortgage Obligation ...

    A type of mortgage-backed security in which principal repayments ...
  2. IRR Rule

    A measure for evaluating whether to proceed with a project or ...
  3. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and ...
  4. Golden Cross

    A crossover involving a security's short-term moving average ...
  5. Cup and Handle

    A pattern on bar charts resembling a cup with a handle. The cup ...
  6. Percentage Change

    Percentage change is a simple mathematical concept that represents ...
RELATED FAQS
  1. When does a growth stock turn into a value opportunity?

    A growth stock turns into a value opportunity when it trades at a reasonable multiple of the company's earnings per share ... Read Full Answer >>
  2. What is Fibonacci retracement, and where do the ratios that are used come from?

    Fibonacci retracement is a very popular tool among technical traders and is based on the key numbers identified by mathematician ... Read Full Answer >>
  3. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  4. What is securitization?

    Securitization is the process of taking an illiquid asset, or group of assets, and through financial engineering, transforming ... Read Full Answer >>
  5. What is the formula for calculating EBITDA?

    When analyzing financial fitness, corporate accountants and investors alike closely examine a company's financial statements ... Read Full Answer >>
  6. How do I calculate the P/E ratio of a company?

    The price-earnings ratio (P/E ratio) is a valuation measure that compares the level of stock prices to the level of corporate ... Read Full Answer >>
Hot Definitions
  1. Liquidation Margin

    Liquidation margin refers to the value of all of the equity positions in a margin account. If an investor or trader holds ...
  2. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  3. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  4. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  5. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
Trading Center