Double top chart pattern

Before reading this lesson, you should have read through:

The double top and double bottom are very common reversal chart patterns. The double top is a bearish pattern that occurs after an uptrend. This means that when you see the pattern you will then look for selling opportunities. This lesson shows you how to identify the pattern and introduces two different ways to trade using the double top pattern.

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Identifying the double top pattern

There are two highs, where the price has attempted to break through a resistance level twice before reversing to the downside. There is also what is called a "neckline", which is considered the bottom part of the pattern.

The chart below demonstrates what a double top pattern looks like:


Doubletop example

number_1 First high
number_2 Second high
number_3 Neckline

What is happening is that the buyers have attempted to push the price through a resistance level at number_1, but were unable to due to the sellers entering the market.

There was a second attempt by the buyers, but they were unable to break through to new highs, shown at number_2, because the sellers entered the market in force once again and overpowered the buyers.

Once it became apparent that the buyers were unable to push the price through the resistance level, the price then reversed to the downside with more sellers entering the market.

Take note that the price must break the neckline of the pattern in order for it to be a valid double top pattern.

Once this pattern has been identified on the price charts, you are then looking for potential selling opportunities.

You can practice how to spot double top patterns in the following exercises:

Exercise 1: Identify the double top pattern Show exercise
Exercise 2: Identify the double top pattern Show exercise

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Trading the double top: method one

We will now look at two different ways to trade the double top.

The first way to trade this pattern is to look for the neckline that is marked on the chart below. Once the price breaks through the neckline, you can then enter the market with a sell order.

The chart below shows the neckline being broken by the price – this is where short traders can enter the market.


Doubletop examplemethod1a

number_1 First high
number_2 Second high
number_3 Neckline
es1 Short trade initiated when the the price breaks through the neckline

The stop loss is placed above the double top. If the price trades beyond this point, the pattern has failed and you do not want to be in the market any longer.

The profit target is measured by taking the height of the actual pattern and extending that distance down from the neckline.

The chart below demonstrates the stop loss (red) and take profit levels (green):

Doubletop examplemethod1 profittarget

number_1 First high
number_2 Second high
number_3 Neckline
number_4 Height of the pattern (red shaded area)
number_5 Same distance as the height of the pattern (red shaded area)
es1 Short entry at break of the neckline
sl2 Stop loss placed above the highs of the patten
tp3 Profit target placed the same distance away as the height of the patten, down from the neckline

You can practice where to place the entry, stop loss and take profit in the following exercise:

Exercise 1: Where would you place your entry, stop loss and profit target? Show exercise

Trading the double top: method two

The second way to trade the double top pattern is to wait for the price to trade below the neckline (broken support) and then look to place a sell order on the retest of the neckline as resistance (broken support now becomes resistance). The stop loss would go above the new resistance area and the profit target would remain the same as in the first example.

The chart below demonstrates the second way a trader can trade the double top pattern showing the entry (orange), stop loss (red) and take profit levels (green):

Doubletop examplemethod2 profittarget

number_1 First high
number_2 Second high
number_3 Neckline
number_4 Height of the pattern (red shaded area)
number_5 Same distance as the height of the pattern (red shaded area)
es1 Short entry at the retest of the neckline as resistance
sl2 Stop loss placed just above resistance, after the price has retested the neckline
tp3 Profit target places the same distance away as the height of the pattern, down from the neckline

You can practice where to place the entry, stop loss and take profit according to method 2 the in following exercise:

Exercise 1: Where would you place your entry, stop loss and profit target? Show exercise

Summary

In this lesson you have leaned that...

  • … the double top chart pattern signals a possible move to the downside and potential selling opportunities.
  • ... you can trade the pattern on the break of the neckline, placing the stop loss above the pattern and the profit target the same distance as the height of the pattern, down from the neckline.
  • ... you can also enter after the price has already broken through the neckline and has retested it as resistance. You place the stop loss above the resistance level and the profit target the same distance as the height of the pattern, down from the neckline.

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  • Just one question. If we trade double top with method one (i. e. placing SL above the double top) would not be our risk reward ratio not very good? I mean, considering the TP level we are supposed to set up according to this method, we will get at best 1:1 rrr. So is this indicator so strong , that we can suppose to take profit at more than 50% of our trades, considering rrr according to method one?

    What would be wrong with trading method one similar to trading S&R in the "agressive" way, i. e. when neckline breaks, we consider it to be breaking of support level and place SL above the neckline? The TP would be placed as stated in article (method one) This would give us much more favourable rrr. Or am I missing something?
  • Hello mrkaktus,
    Good question smile

    There is no perfect method to approach such a pattern. My mind is, whatever the depicted setup above, you might consider the profit line as a minimum potential of gain.

    If you wish to trade such a pattern, I could recommend you to look for several double-top patterns (on past data for example) and for each found pattern, you could test different setups, varying SL placements for example, and finally able to see, what kind of setup most suits you (in terms of beliefs, expectancy...).

    Hope that helps. Happy trading!
    Sebastien
  • Hey mrkaktus,

    As with all trading techniques, you get base rules and then you get variations and discretion. Now double top trading patterns have been around for years and it is one of the favorites of traders. However, success will always be done to the exits and money management, as you have correctly pointed out.

    To answer your question, there would be nothing wrong with your suggested method is trading method one and then moving the stop loss - this, in my opinion, would be a very good variation because you get the benefit of the strong signal that the double top gives you, combined with the benefit of decreased risk.

    What you are now doing is taking a technique and making it your own and using your own thinking to navigate your way around the markets. This is very good.

    What I would encourage your to do, as you seem to be on the way to developing your own way of trading, is check out our lessons on Manually backtesting the trading strategy.
  • Hi there,
    I think it is a great buying opportunity if the price breakouts the double top pattern.
  • Hi JHTAN,

    This is a bit contradicting if the price breaks above the double top than technically the double top pattern is not confirmed. and indeed there would not be a reversal but a continuation.

    Regards,
    Timothy
  • [IMG]http://imagizer.imageshack.us/v2/800x600q90/822/epps.png[/IMG]
    With respect to risk to award ratio, it's not a good trade?
    Thanks.
  • I was thinking the same mrkatus, having the tighter stop above the neckline appeals to me more because of the better r/r like you said.
  • Hi Pockettones,

    Keep in mind tighter stops can also result in stopouts which occur to fast, you have to test it a bit to see what you like more.

    Regards,
    Timothy
  • I guess this article fails to give good take profit level in either methods. I would like to think simpler: once the neckline is broken down, sell and put take profit level at exact value of the next support/resistance level.
  • Hi Marhahs,
    If 1:1 RR is not suited for your risk appetite, try MrKaktus' method up here in the comment section:
    http://en.tradimo.com/co/520885ad5d2b948a690000e0/
    Let me know what you think.
    Regards
    Peter
  • Hi hindsighthero,

    Thanks for your comment. My point is not about the ratio. It is about the logic behind take profit and stop loss levels.

    I tend to think simple. Consider an example: the price moves up and is able to break a resistance R1. Then it reaches a high H1=R2 and reverses and somewhere at S1 (above R1) it makes a comeback and touches H1 again. But it can not break and reverses and comes to S1 and breaks down. That is we have completed a double top pattern. We enter short somewhere below S1. Now I guess logically we put the take profit on R1 and stop loss a bit above H1. This will have nothing to do with ratios but rather with support and resistance which are marker natural reaction levels. If no good R1 can be identified then use some Fibonacci levels.

    This seems to me logical.

    Regards

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