What is a Double Top Pattern?

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Synopsis:

A double-top chart pattern is a price reversal pattern. If it is correctly established, it shows that the probability that the price will decline is extremely high.

If you have just opened a trading account, you might have heard about a double-top pattern. You might have even wondered about the meaning of a double-top pattern. It is a stock market pattern, which investors have devised over the years to predict the direction of stock prices.

It is a price reversal pattern, which means that it indicates a reversal in a price trend. In other words, it shows that prices will move in an opposite direction compared to the direction they were moving in till recently. Now, let us take a deep dive into this pattern.

What is a Double-Top Pattern?

This pattern is extremely bearish, which means once it is formed there is a high probability that the stock price will move downward. It is an M-shaped pattern. It occurs when the price of a security reaches a high point, and then experiences another high point. Between these two peaks, there is a slight decline in the price.

While the pattern is formed at this stage, it takes a while to confirm it. After making this M-shape, if a security’s price declines and breaches the support level, then the double-top pattern is confirmed.

Once a security’s price reaches a peak and then falls a bit and then rises a bit but does not rise enough to reach the previous peak, it shows that it may lose the upward momentum. Therefore, as a trader, you should be watchful. And then if the price starts declining to such an extent that it falls beyond the support level, the probability is high that the price will remain bearish for a while.

How to Find a Genuine Double Top Pattern and Not a Fake One?

Just like any other technical pattern, there is an issue with this pattern, too. At times, traders think they have identified a double top chart pattern, but it turns out to be a fake one, which may result in them making losses. Hence, the question arises: How to identify a genuine double top pattern? To do that, you need to follow these steps:

  • Find an upward movement in the price: Before the creation of a double top, there should definitely be an upward movement in the price. This is a price reversal pattern. If the price has to reverse to start declining, it must rise first.

  • Identify the initial peak: Then, you need to identify the initial peak of the price. This will show that the price has risen the most and now it may begin to fall.

  • Look out for the trough: After the price reaches a peak, it will fall for some time, creating something like a valley or trough. You need to identify it.

  • Identify the second peak: Once a trough is created, the price will begin to rise again, but this time it will not be able to rise to reach the level of the initial peak. You need to identify this second peak.

  • Pattern to be verified: Now, you need to verify the pattern. For this, you need to check whether the decline that happened after the price hit the second peak is lower than the trough that was made after the first peak. After this, you should create a horizontal line to join the low points of the two troughs. This is called a neckline, which shows a level of support. Once the price falls below the neckline, you can say that it is a signal to sell because the probability is high that the price will keep falling.

Role of Volume in the Formation of a Double Top Pattern

As is the case with other technical indicators, volume plays a critical role here, too. In a double top pattern, it typically happens that volume decreases during the formation of the two peaks. This means that the upward movement in price is losing strength.

However, when the price falls below the neckline, volume usually increases. This shows that people are selling that security with higher volumes when its price is declining. Therefore, the probability is very high that the price will keep on falling. As a trader, you should always analyse the volume of a security along with its price. If you analyse price alone, you may end up with wrong signals.

Conclusion

While a double top pattern often provides a great opportunity for traders, they still need to be careful. Besides, there is a great degree of subjectivity involved. Not all traders may agree on the formation of a peak and trough. Therefore, as a trader, you should be careful while using this pattern as a share market strategy.

Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.

This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.

For All Disclaimers Click Here: https://bit.ly/3Tcsfuc

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