Double Top & Bottom (Reversal)

<<<<<<< HEAD

The Double Top and Double Bottom reversal chart patterns do exactly what they say on the tin.  After an up trend two peaks form as the trend encounters resistance, or two bottoms form when support is found.  The price reversal may then take place.  So, these patterns make great use of support and resistance levels and anticipate a rebound from either, depending on whether the chart forms a double bottom or top. These two reversal patterns illustrate the markets attempt to continue an existing trend, but upon several attempts to continue the trend, the psychological state of the market changes and the trend can reverse. The chart patterns formed will often resemble what looks like a “W” (for a double bottom) or an “M” (double top).

The Double Top Reversal

The double-top pattern is found at the up-most peak of an upward trend and is a "clear" signal  (as clear as can be in T.A) that the preceding upward trend is weakening and that buyers are losing interest. Upon completion of this pattern, the trend is considered to be reversed and the market has a  higher than average probability of moving lower. 

Double Top Chart Pattern
FTSE 100 - Example of The Double Top Chart Pattern


As seen in our chart of The FTSE 100 share index – Buyers are demanding this market at ever higher prices & supply is willing at these prices (See The Price, Volume, Demand & Supply Relationship in Mod 1). This supply/demand tango continues until point 1 where resistance is encountered. This resistance may have been caused by historical support or resistance (off chart), or a psychologically important number. In any even the demand and supply dynamic has changed (see Support and resistance in Module 1). Bears have now taken hold as supply overtakes demand at these prices - price now falls until support is found at point 2. At this support level the bulls want to test previous resistance and perhaps try continue the original trend, but once again they just can't cross that bridge. For a second time the bears take hold, driving price down. This time the bulls have learned their lesson and there's no appetite to get back into the market, so support is broken at point 4 with continual downward prices.  There can sometimes be a degree of wavering to cross the support level after the second peak.  This has happened in our example.  In mid May price crossed support, where it retraced back a little, before breaking support at the end of may.  Just be aware of this when trading and we'll talk about this more in 'Trading the Double Top Patter' below.

Importance of Volume
Volume is an important indicator to use in this situation. During the formation of the pattern the advance off of the low going into the 2nd peak will usually be accompanied with low volume, showing lack of enthusiasm for the continuation of the original trend.  One should look for an increase in volume when the security falls below the support level after the 2nd peak. This spike in volume as the price moves through point 4 support can be confirmation that the pattern is promising the reversal.  

Key Features of The Double Top Chart Pattern
Below I've highlighted some key points of the double top chart pattern.  They are for guidance only and shouldn't be seen as gospel:
  • A prior up trend must be observed.  If we're already in a range it won't be a double top.
  • First peak is the high of the preceding trend
  • 1st trough typically retraces between 10% & 20% from the 1st peak.
  • The advance to the 2nd Peak should accompanied by low volume
  • Peaks should not be close together, as this may signify only short tern resistance and not a reversal.
  • The whole pattern can take many months or a few days to form - 1 to 3 months is the average
  • Increased volume after 2nd peak
  • Don't jump the gun to start the trade.  The support break after 2nd peak should be accompanied by large peak in volume for confirmation, even then you may want to wait for a few days to enter.
  • After confirmation a price target equal to the height between peak and support is achievable.
Trading The Double Top Pattern
Traders wait for the break of the support level as confirmation that the double top chart pattern has reversed.  In our example of the FTSE 100 this support is broken at point 4 in late May and just before it in mid may.  Traders will enter the trade when the price closes below the support, or when there's a full candle visible below support, or when price passes support by 2 to 3%, or wait a few days after the break.  It all depends on your appetite to risk.

I'll take you through the trade point by point:
  • Enter trade at point 5 after a full candle has passed support at closing price = £5120
  • A stop/loss should probably be placed to cover any nasty surprises.  Here the stop loss is placed above £5300 - Why?  Because sometimes price will retrace back over support and stop the trade out at a loss.  If it's placed above a previous resistance level, then the trade is more likely to run.  If you are less risk averse then a stop loss just above support around 5200 could be placed, but you'll have more chance of stopping out (See out future modules on stop/loss).  If we entered the trade in mid May when price closed below support the first time, we may have been stopped out.  The trade needs room to breathe.
  • The trade price target from support is equal to the range height.  Our range height = £5285 - £5150 = £135, so our target price is £5150 - £135 = £5015
  • On this occasion the trade hit our profit target exactly in early June.  Profit £5120 - £5015 = £105.
  • Many traders will be using the same pattern, so they'll all be expecting the same price target.  Don't be surprised if it hits is perfectly before retracing.  

What's The Double Bottom? Another View...

While the cup with handle is the most common stock chart pattern among great winners, the double bottom also pops up frequently — and has a similar look. It initially resembles a cup with handle, but then the handle slants way, way down. So far down that it no longer is a proper handle, and the overall structure instead takes on a W-like shape.

The second part of the W actually undercuts the first. Look at the double-bottom base that Ulta Beauty formed in 2010 1, as shown in the chart accompanying this column.

The Double Bottom Chart Pattern

In early August 2010 2, it might have appeared as though Ulta was en route to etching a cup with handle. But the specialty retailer of cosmetics, beauty products and hair salon services made another move down, touching a fresh six-month low at 20.67 on Sept. 1, 2010.

So when do double bottoms generally occur?
As with any base, they often begin to take shape when the general market itself experiences an intermediate correction. You frequently get the second half of the pattern for a leading stock when the market tries to rally, then falls back into correction mode. 

That's exactly what happened with Ulta. The market was in an uptrend from early July through early August, as noted at that time in IBD's The Big Picture column and Market Pulse graphic. But the uptrend came under pressure in mid-August, and then the market fell into a brief correction in late August. Ulta etched the second half of its double-bottom structure during this period.

The next confirmed uptrend began with a follow-through day on Sept. 1, 2010. This turned into a strong uptrend that helped unleash plenty of big advances by highly rated stocks, including Ulta. Ulta broke out on Sept. 3, a couple of sessions after the follow-through day. It cleared a buy point at 25.99. With any double bottom, the entry comes from the middle peak in the W-like pattern.

For Ulta, the middle peak was at 25.89, so you just add a dime to get the buy point at 25.99. The breakout on Sept. 3 drew strong turnover 3 , just like you want to see. On a weekly basis, turnover was the strongest it had ever been for Ulta, which went public in 2007.

Written by VICTOR REKLAITIS
Double Bottom Reversal

The double-bottom pattern is found at the bottom-most trough of a down trend and is a clear signal that the preceding down trend is weakening and that sellers are losing interest. Upon completion of this pattern, the trend is considered to be reversed and the security is expected to move higher.

As with the double top chart pattern the double bottom pattern usually forms over the intermediate to long-term (1 month onwards).  It can be found in other circumstances though after a trend.  It's never found in a range. Everything we've talked about for the double top pattern applies to the double bottom chart pattern, only in reverse.  The below chart of MXB shows the double bottom pattern.  You'll see that the second trough doesn't quite hit support, but it's still a valid pattern. 

Further reading on the double bottom reversal can be found under Mod 6. Trading Psychology - The "Shake-out". You'll get further perspective on the psychology involved with this chart pattern


MXB - Example of The Double Bottom Chart Pattern

Patterns Aren't Always So Perfect
Often in TA and chart patterns, we're presented with an ideal chart setup; but in reality the pattern doesn't always look as perfect as it's supposed to. In double tops and double bottoms one thing to remember is that the price on the second peak or trough doesn't always need to reach the same distance as the first test. Another problem that can occur is the second peak or trough can actually break the resistance level that the first top or bottom created. If this occurs, it can give a signal that the previous trend will continue, especially if volume starts to increase. However, don’t be too quick to abandon the pattern as it could still materialize.

The double tops and double bottoms are strong reversal patterns that can provide trading opportunities. But it is important to be careful with these patterns as the price can often move either way. Consequently, it's important that the trade is implemented once the support/resistance line is broken.  One draw back of this pattern is that it's not trend trading, so less predictable.


=======

The Double Top and Double Bottom reversal chart patterns do exactly what they say on the tin.  After an up trend two peaks form as the trend encounters resistance, or two bottoms form when support is found.  The price reversal may then take place.  So, these patterns make great use of support and resistance levels and anticipate a rebound from either, depending on whether the chart forms a double bottom or top. These two reversal patterns illustrate the markets attempt to continue an existing trend, but upon several attempts to continue the trend, the psychological state of the market changes and the trend can reverse. The chart patterns formed will often resemble what looks like a “W” (for a double bottom) or an “M” (double top).

The Double Top Reversal

The double-top pattern is found at the up-most peak of an upward trend and is a "clear" signal  (as clear as can be in T.A) that the preceding upward trend is weakening and that buyers are losing interest. Upon completion of this pattern, the trend is considered to be reversed and the market has a  higher than average probability of moving lower. 

Double Top Chart Pattern
FTSE 100 - Example of The Double Top Chart Pattern


As seen in our chart of The FTSE 100 share index – Buyers are demanding this market at ever higher prices & supply is willing at these prices (See The Price, Volume, Demand & Supply Relationship in Mod 1). This supply/demand tango continues until point 1 where resistance is encountered. This resistance may have been caused by historical support or resistance (off chart), or a psychologically important number. In any even the demand and supply dynamic has changed (see Support and resistance in Module 1). Bears have now taken hold as supply overtakes demand at these prices - price now falls until support is found at point 2. At this support level the bulls want to test previous resistance and perhaps try continue the original trend, but once again they just can't cross that bridge. For a second time the bears take hold, driving price down. This time the bulls have learned their lesson and there's no appetite to get back into the market, so support is broken at point 4 with continual downward prices.  There can sometimes be a degree of wavering to cross the support level after the second peak.  This has happened in our example.  In mid May price crossed support, where it retraced back a little, before breaking support at the end of may.  Just be aware of this when trading and we'll talk about this more in 'Trading the Double Top Patter' below.

Importance of Volume
Volume is an important indicator to use in this situation. During the formation of the pattern the advance off of the low going into the 2nd peak will usually be accompanied with low volume, showing lack of enthusiasm for the continuation of the original trend.  One should look for an increase in volume when the security falls below the support level after the 2nd peak. This spike in volume as the price moves through point 4 support can be confirmation that the pattern is promising the reversal.  

Key Features of The Double Top Chart Pattern
Below I've highlighted some key points of the double top chart pattern.  They are for guidance only and shouldn't be seen as gospel:
  • A prior up trend must be observed.  If we're already in a range it won't be a double top.
  • First peak is the high of the preceding trend
  • 1st trough typically retraces between 10% & 20% from the 1st peak.
  • The advance to the 2nd Peak should accompanied by low volume
  • Peaks should not be close together, as this may signify only short tern resistance and not a reversal.
  • The whole pattern can take many months or a few days to form - 1 to 3 months is the average
  • Increased volume after 2nd peak
  • Don't jump the gun to start the trade.  The support break after 2nd peak should be accompanied by large peak in volume for confirmation, even then you may want to wait for a few days to enter.
  • After confirmation a price target equal to the height between peak and support is achievable.
Trading The Double Top Pattern
Traders wait for the break of the support level as confirmation that the double top chart pattern has reversed.  In our example of the FTSE 100 this support is broken at point 4 in late May and just before it in mid may.  Traders will enter the trade when the price closes below the support, or when there's a full candle visible below support, or when price passes support by 2 to 3%, or wait a few days after the break.  It all depends on your appetite to risk.

I'll take you through the trade point by point:
  • Enter trade at point 5 after a full candle has passed support at closing price = £5120
  • A stop/loss should probably be placed to cover any nasty surprises.  Here the stop loss is placed above £5300 - Why?  Because sometimes price will retrace back over support and stop the trade out at a loss.  If it's placed above a previous resistance level, then the trade is more likely to run.  If you are less risk averse then a stop loss just above support around 5200 could be placed, but you'll have more chance of stopping out (See out future modules on stop/loss).  If we entered the trade in mid May when price closed below support the first time, we may have been stopped out.  The trade needs room to breathe.
  • The trade price target from support is equal to the range height.  Our range height = £5285 - £5150 = £135, so our target price is £5150 - £135 = £5015
  • On this occasion the trade hit our profit target exactly in early June.  Profit £5120 - £5015 = £105.
  • Many traders will be using the same pattern, so they'll all be expecting the same price target.  Don't be surprised if it hits is perfectly before retracing.  

What's The Double Bottom? Another View...

While the cup with handle is the most common stock chart pattern among great winners, the double bottom also pops up frequently — and has a similar look. It initially resembles a cup with handle, but then the handle slants way, way down. So far down that it no longer is a proper handle, and the overall structure instead takes on a W-like shape.

The second part of the W actually undercuts the first. Look at the double-bottom base that Ulta Beauty formed in 2010 1, as shown in the chart accompanying this column.

The Double Bottom Chart Pattern

In early August 2010 2, it might have appeared as though Ulta was en route to etching a cup with handle. But the specialty retailer of cosmetics, beauty products and hair salon services made another move down, touching a fresh six-month low at 20.67 on Sept. 1, 2010.

So when do double bottoms generally occur?
As with any base, they often begin to take shape when the general market itself experiences an intermediate correction. You frequently get the second half of the pattern for a leading stock when the market tries to rally, then falls back into correction mode. 

That's exactly what happened with Ulta. The market was in an uptrend from early July through early August, as noted at that time in IBD's The Big Picture column and Market Pulse graphic. But the uptrend came under pressure in mid-August, and then the market fell into a brief correction in late August. Ulta etched the second half of its double-bottom structure during this period.

The next confirmed uptrend began with a follow-through day on Sept. 1, 2010. This turned into a strong uptrend that helped unleash plenty of big advances by highly rated stocks, including Ulta. Ulta broke out on Sept. 3, a couple of sessions after the follow-through day. It cleared a buy point at 25.99. With any double bottom, the entry comes from the middle peak in the W-like pattern.

For Ulta, the middle peak was at 25.89, so you just add a dime to get the buy point at 25.99. The breakout on Sept. 3 drew strong turnover 3 , just like you want to see. On a weekly basis, turnover was the strongest it had ever been for Ulta, which went public in 2007.

Written by VICTOR REKLAITIS
Double Bottom Reversal

The double-bottom pattern is found at the bottom-most trough of a down trend and is a clear signal that the preceding down trend is weakening and that sellers are losing interest. Upon completion of this pattern, the trend is considered to be reversed and the security is expected to move higher.

As with the double top chart pattern the double bottom pattern usually forms over the intermediate to long-term (1 month onwards).  It can be found in other circumstances though after a trend.  It's never found in a range. Everything we've talked about for the double top pattern applies to the double bottom chart pattern, only in reverse.  The below chart of MXB shows the double bottom pattern.  You'll see that the second trough doesn't quite hit support, but it's still a valid pattern. 

Further reading on the double bottom reversal can be found under Mod 6. Trading Psychology - The "Shake-out". You'll get further perspective on the psychology involved with this chart pattern


MXB - Example of The Double Bottom Chart Pattern

Patterns Aren't Always So Perfect
Often in TA and chart patterns, we're presented with an ideal chart setup; but in reality the pattern doesn't always look as perfect as it's supposed to. In double tops and double bottoms one thing to remember is that the price on the second peak or trough doesn't always need to reach the same distance as the first test. Another problem that can occur is the second peak or trough can actually break the resistance level that the first top or bottom created. If this occurs, it can give a signal that the previous trend will continue, especially if volume starts to increase. However, don’t be too quick to abandon the pattern as it could still materialize.

The double tops and double bottoms are strong reversal patterns that can provide trading opportunities. But it is important to be careful with these patterns as the price can often move either way. Consequently, it's important that the trade is implemented once the support/resistance line is broken.  One draw back of this pattern is that it's not trend trading, so less predictable.


>>>>>>> c0fd65f8ac5b5830dc3df1d307fcababd602b3a9
Comments