What Is Double Top and Bottom?
Double top and bottom patterns are chart patterns that occur when the underlying investment moves in a similar pattern to the letter "W" (double bottom) or "M" (double top). Double top and bottom analysis is used in technical analysis to explain movements in a security or other investment, and can be used as part of a trading strategy to exploit recurring patterns.
- Double tops and bottoms are important technical analysis patterns used by traders.
- A double top has an 'M' shape and indicates a bearish reversal in trend.
- A double bottom has a 'W' shape and is a signal for a bullish price movement.
Understanding Double Tops and Bottoms
Double top and bottom patterns typically evolve over a longer period of time, and do not always present an ideal visual of a pattern because the shifts in prices don't necessarily resemble a clear "M" or "W". When reviewing the chart pattern, it is important for investors to note that the peaks and troughs do not have to reach the same points in order for the "M" or "W" pattern to appear.
Double top and bottom patterns are formed from consecutive rounding tops and bottoms. These patterns are often used in conjunction with other indicators since rounding patterns in general can easily lead to fakeouts or mistaking reversal trends.
Double Top Pattern
A double top pattern is formed from two consecutive rounding tops. The first rounding top forms an upside-down U pattern. Rounding tops can often be an indicator for a bearish reversal as they often occur after an extended bullish rally. Double tops will have similar inferences. If a double top occurs, the second rounded top will usually be slightly below the first rounded tops peak indicating resistance and exhaustion. Double tops can be rare occurrences with their formation often indicating that investors are seeking to obtain final profits from a bullish trend. Double tops often lead to a bearish reversal in which traders can profit from selling the stock on a downtrend.
Double Bottom Pattern
Double bottom patterns are essentially the opposite of double top patterns. Results from this pattern have the opposite inferences. A double bottom is formed following a single rounding bottom pattern which can also be the first sign of a potential reversal. Rounding bottom patterns will typically occur at the end of an extended bearish trend. The double bottom formation constructed from two consecutive rounding bottoms can also infer that investors are following the security to capitalize on its last push lower toward a support level. A double bottom will typically indicate a bullish reversal which provides an opportunity for investors to obtain profits from a bullish rally. After a double bottom, common trading strategies include long positions that will profit from a rising security price.
Limitations of Double Tops and Bottoms
Double top and bottom formations are highly effective when identified correctly. However, they can be extremely detrimental when they are interpreted incorrectly. Therefore, one must be extremely careful and patient before jumping to conclusions.
For instance, there is a significant difference between a double top and one that has failed. A real double top is an extremely bearish technical pattern which can lead to an extremely sharp decline in a stock or asset. However, it is essential to be patient and identify the critical support level to confirm a double top's identity. Basing a double top solely on the formation of two consecutive peaks could lead to a false reading and cause an early exit from a position.