Stock analysis is one of the starting points for investment or trading in stock markets. This study is broadly divided into two categories namely, fundamental analysis and technical analysis. While fundamental analysis is the study of company financials as well as that of the industry and economy as a whole, technical analysis is the study of the price and volume movements of the stocks. There are many strategies and patterns that help investors and traders understand the movement of the stocks and the market trends. One of such patterns commonly used in trading is the double top and double bottom pattern.
Given below are the meaning and other details relating to the same.
What is the double top pattern?
A double top pattern is a trend reversal pattern that indicates the reversal of the current bullish trend to signal the onset of the downtrend. Under this pattern, there is a formation of 2 peaks, also known as twin peaks, at an approximately similar price. These peaks form an ‘M’ shape under the double top pattern. These peaks are separated by a valley shape that is at the point of the minimum price. This price level at the valley is known as the neckline. When the price falls below the neckline the pattern formation is said to be complete. It then confirms that the price is about to fall and may continue falling in the near future till there is another trend reversal in place.
The double bottom pattern is the exact reverse of the double top pattern. It indicates the reversal of the current bearish trend and the onset of the uptrend. It forms a ‘W’ shaped pattern that has two bottom peaks which are formed below the resistance level. These peaks are separated by a valley that is known as a neckline and when this neckline breaches the resistance level, a bearish trend reversal is confirmed. The pattern is completed when the prices rise above the neckline to indicate the further continuation of the price rise.
Double top patterns and double bottom patterns are known as the trend reversal patterns that are often used by traders and analysts to understand the market conditions as well as predict market sentiments. Some of the key differences between the two patterns are tabled below.
|Category||Double Top Pattern||Double Bottom Pattern|
|Pattern formation||This pattern is easy to identify and is in the form of ‘M’.||This pattern is easy to identify and is in the form of ‘W’.|
|Indication of trend||This pattern indicates the reversal of the bullish trend and the onset of the downtrend.||This pattern indicates the reversal of the bearish trend and the onset of the uptrend.|
|Use of stop loss||Stop loss is to be put at the second top in this pattern to avoid the possibility of maximum losses.||Stop loss is to be put at the bottom of the second low in this pattern to avoid the possibility of maximum losses.|
|Position of neckline for confirmation of trend reversal||When the position of the neckline in this pattern breaks the support levels, it indicates the confirmation of bearish trend reversal.||When the position of the neckline in this pattern breaks the resistance levels, it indicates the confirmation of a bullish trend reversal.|
How to trade using these patterns?
Double top and double bottom chart patterns are one of the many chart patterns that can be used by investors and traders to take suitable trading positions to curate a profitable portfolio. The analysis of these patterns and the way to trade using the same is mentioned below.
- Double top pattern
First and foremost it is important to correctly identify the double top pattern. It is indicative of a reversal of the upward trend, hence, prima facie there needs to be an upward trend in place. The next step is to spot two definitive peaks and also take into account if such peaks are backed by adequate volume. Traders need to take a short position when the price breaches the support levels to confirm the upcoming trend. It is important to note that traders need to put a stop loss in place at the second peak to avoid extreme losses and the price target should be equal to the gap between the support and the peaks.
- Double bottom pattern
Similar to the double top pattern, the double bottom pattern also needs to be identified correctly. It is easy to misinterpret the double bottom pattern, therefore, the primary step is to identify the presence of the prevailing bearish trend. Following this, traders need to identify the formation of twin bottom peaks which are backed by adequate volume. Traders can take a long position when the price breaks the resistance levels to confirm the upcoming bullish trend. Stop loss, in this case, has to be placed at the second lower peak in the double bottom pattern and the price target should be equal to the gap between the resistance and the peaks.
While these patterns are relatively easier to spot, it is imperative to know that they cannot be used on their own. Traders and analysts need to use other indicators and volume for confirming the double bottom or double top patterns. These patterns are usually used for taking short-term positions as is the case with most traders using technical analysis tools.
The prime indicator of the double top pattern is the creation of twin peaks that form the pattern ‘M’.
The basic requirement for the identification of a double bottom pattern is the presence of the prevailing bearish trend that is set to be reversed.
A double top pattern indicates the start of the bearish trend and therefore traders are advised to take short positions, i.e, sell their holdings.
No, it is not advisable to use double top or double bottom patterns as a single point of reference for trend reversals. These patterns have to be backed by sufficient volume and other indicators for further confirmation.