Double top and Double Bottom are price action pattern formations identified to predict the behaviour of the market. As the name suggests, Double Top is when the price action forms two peaks almost equal to each other, and the Double Bottom is when the price action dips to form two consecutive bottoms with only a peak separating the two. Of all the chart pattern formations, Double Top and Double Bottom could pass as one of the easiest-to-identify.
Double Top is formed when the market follows the uptrend and then pulls back. The pullback must have created a peak to its left in order to form a trough. The price, then again rallies to form the second peak almost equal to the first, then drops again lower than the trough. The second peak, unable to break through the limit set by the first, marks the resistance and reduction in buying, thereby calling out a potential reversal.
The right place to draw the neckline is at the lowest point of the pullback. The price rises from the trough to form the second peak and drops back again to the neckline completing the formation of Double Top and the opportunity.
The right time to enter the trade is by the completion of the pattern formation. When the shaky line from the second peak downs to the neckline signifying the uptrend reversal, it plunges deep breaking through the neckline. Shorting is the obvious option for profit since the prices are dropping.
The safest exit with considerable profit is calculated from the neckline with the same value as the height of the peaks.
In case, worse comes to worst and you misinterpret the chart for a double top, Stop Loss is the measure to keep your loss to the minimum. It is better to limit the loss to the latest peak created within the pattern.
On contrary to the double top, the double bottom is identified by a dip, followed by a rise, which is again followed by a dip. In the downtrend, the price forms a trough by pulling back to the upside. The price drops again to a point above the first trough unable to drop lower signifying the reducing sellers, thereby marking the downtrend reversal. The price then rallies all the way up until it falls short of buyers or reaches a balancing point.
Here, Neckline is the plane drawn to connect both troughs through the edge of the middle peak.
Similar to the double top, it is best to enter the trade by the completion of the double bottom. When the price rallies towards the neckline, it goes all the way up breaking through the neckline. So going long at the neckline makes the most of the opportunity.
The position in the uptrend, marked from the neckline with the same value as the height of the troughs, is safe to close the trade.
Stop Loss for the Double Bottom is set at the recent trough formed inside the pattern to limit the loss which are inevitable.
Double Top and Double Bottom are trend reversal patterns, which even the traders who disregard the chart patterns look forward to. These are simple trading patterns and doesn’t require much expertise to be able to identify, but the only shortcoming is that the reward: risk ratio is not too tempting. The ratio can be made favourable by setting stop loss in a much closer position. It is advised to take the trade only when the potential for profit is sound.