A double top is a chart pattern, characterized by two consecutive peaks in price, that signals a potential bearish reversal of an uptrend.
The double top chart pattern is considered to be an indicator of an intermediate- or long-term reversal in price. After two attempts by bulls to push the price above key resistance levels, many bulls may capitulate and bears often take control over the market price.
Here's an example of a double top chart pattern:
In this example, the double top pattern forms at around $115.00 with a trough around $105.00. Upon breakdown at around $105.00, traders may have initiated a short position for a gain of up to five percent over the course of a few sessions.
Traders often use other technical indicators and chart patterns in conjunction with the double top before initiating a short position. In the example above, the double top pattern resulted in a breakdown, but the trend soon reversed direction again. By looking for confirmations, traders can avoid losing capital due to a whipsaw or false breakdown.
The inverse of the double top chart pattern is a double bottom, which signals a potential bullish reversal of a downtrend.
The double top chart pattern occurs at the top of a prolonged uptrend. After reaching a high, such as a 52-week or all-time high, the price moves significantly lower to make a trough before making another attempt at breaking out to new highs. The second peak comes close to reaching the first peak, but occurs with relatively low volume as bulls lose confidence in the rally. As the price drops again, the volume begins to accelerate as bears take control over the market and bulls exit their positions.
The bearish chart pattern is confirmed when the price breaks down below the low point of the trough. Often times, traders watch for a high volume breakdown from this level and then initiate a short position to capitalize on the intermediate- to long-term reversal. The trough low point turns into a key resistance level after the breakdown, which helps support short-sellers.
When coming up with a price target for the short trade, most traders calculate the distance between the peaks and trough and then subtract that amount from the low point of the trough. For example, if the peaks were at or near $100.00 and the trough low point was $90.00, traders may initiate a short position at $90.00 upon a breakout with a price target of $80.00 (or, $90.00 - ($100.00 - $90.00)).