What is a double top?

Double Tops are an important part of any Forex Trading Strategy as they can provide an early indication that the current trend is changing direction from an uptrend to a downtrend.

A typical double top starts with a prolonged rise in price for a currency, followed by a drop and then another rise to about the same level as the original rise. Finally, we see another substantial drop off from the second high. The double top pattern should eventually emulate the letter "M".

Double tops are great indicators that a loss of momentum is occurring because the second price rally fails to make a new high, which indicates that the uptrend is losing momentum. Put simply, it is the first time in an uptrend cycle where fewer buyers are willing to buy and more sellers are now willing to take profits.

With diminishing buyers and increased sellers there is now a high probability for a trend change occurring.

At the completion to of a double top pattern it is now time to exit your long trade and considering selling that cross currency shot.

How to spot a double top pattern

As with any top reversal pattern a solid uptrend must be in place. Just as the name implies this top reversal pattern is indicated by two distinct peaks made at approximately the same level as indicated in the figure below by points A and B with a “neckline” or "trough" labelled point C.

After the first peak, a trough takes place that typically ranges from 10 to 20%.  It is important that you can identify two distinct peaks at this point. Peaks and troughs don’t need to be identical as long as the M shaped pattern shows a flattening in the momentum of the trend.

Good quality uptrend must lead into pattern.

Showing signs of weakening momentum.

1 distinct top (B) surrounded by 2 lower highs (A) and (C)

Pattern setup is completed when prices breaches the (D) level.

Often prices re-tests the resistance level at D and then Continues to the downside.

How to trade double top forex patterns

The pattern setup is confirmed when the price breaks below the Trough (=support line) between those 2 peaks. The trading signal has now been triggered and a short position can be taken when the price of the currency pair breaks below the support line as indicated below.

Place a stop-loss order just above the high of the second peak. If the price rallies higher than the second peak, it’s a signal that buyers have returned and the old trend is resuming.

Often there is a second opportunity to enter this trade, and that is when the price rallies back up to the support line which then acts as a resistance level. Therefore a more conservative Forex Trading Strategy would be to only go short after a little reversal and retest of the trough and to then place a stop-loss just above the resistance level.

There is a correlation between the magnitude of the initial uptrend and the size of the following downtrend. The larger the initial uptrend the bigger the fall. Often a profit target is set according to the Fibonacci series with the first profit target being about a 33% decline from the length of the initial uptrend and the second profit target being 50%. Your trading software should allow you to easiy plot these Fibonacci lines.

Double to tips

A word of caution: While the Double Top formation may seem straight forward and simple it can be treacherous to trade, partly because of their similarity to triple tops and trading ranges. Many false double tops can form along the way up, but until key support is broken, a reversal cannot be confirmed so be patient to wait for the support level to be violated.

To confirm that a double top is taking place it is often imformative to examine momentum indicators, such as the MACD indicator, as further confirmation.

Published on 10th of April 2011
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