The Double Top Pattern is a very strong bearish signal that shows that the market’s buyers have pushed prices to new highs twice, yet failed to continue the uptrend. The psychology of the pattern is that buyers will find that they simply do not have the strength to continue the uptrend, and that they suddenly find themselves losing money. Since they have to sell the pair back in order to cover their long positions only adds to the power of this technical pattern.
The pattern itself starts with a long uptrend, followed by a fall in the pair as sellers come in to offer resistance. A little later, the fall weakens, and the buyers come back in force. However, when they push prices back up to the previous highs, they find they cannot continue the uptrend.
The pattern often means that the trend is changing. The buyers who were once in control are quickly finding themselves unable to bid the pair up. Not only has this happened, but many of them will get caught in the fall up as their positions are suddenly worth much less, and eventually losing money. When that happens, those traders will exit their positions, and as mentioned above, have to sell in order to do so. This of course, means more selling pressure, which means the pattern continues to the downside.
The pattern looks like a large “M”, and is one of the most powerful trend change signals you can see. A prudent trader will wait until the center of the pattern is broken below. In other words, the “valley” in the middle of the “M”. Take a look at the chart below to see the double top represented by the two red circles, and the point in which the sell signal is activated represented by the blue circle.
As a general rule, the larger the previous uptrend, the larger the move will be to the downside. When these patterns form on larger timeframes, the pattern can be lethal if used properly as it can lead to weeks and weeks if not months or years of a trending move.
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