Trading using Double Top pattern and Double bottom pattern
Chart patterns form an integral part of technical analysis. New traders and experienced traders use the patterns to analyze price movements, to study the strength of underlying trends, and to predict the future price. Patterns repeatedly occur in the markets but have varying forms of success rates. One of the most significant occurring reversal patterns is the double top pattern and double bottom pattern, and the triple top and triple bottom pattern.
Contents
- Double top candlestick pattern
- How to identify double top pattern
- Double top pattern forex trading
- Double top pattern intraday trading
- Double Bottom Pattern forex trading
- How to trade double bottom pattern
- Double bottom pattern meaning
- Using additional confirmations
- Different ways to trade the pattern
- Triple Bottom Pattern
- Triple Top Pattern
- Limitations
- Conclusion
Double top candlestick pattern:
The above picture shows a double top pattern formed in GBPJPY daily chart. The first top formed at point A and prices retraced to point C. At point C prices stopped retracing and pushed higher to challenge the previous top A, however, once price reached point B, price movement stalled and the rally was unable to reclaim and move higher than point A. The price point A and B effectively formed a double top chart pattern.
How to identify double top pattern:
Picture B illustrates the components of the double top pattern to identify the pattern properly. The price rallied and formed a top at point A, this is the first top of the pattern. The prices then retraced to the lowest retracement point C and then made a second top at B, slightly lower than the first top A. The second top B may not be equal to the first top A, it can be slightly higher or lower than the first top A. The prices then moved to E which is the halfway or the midpoint between the first top A and lowest retracement point C. The pattern is confirmed only when the price makes a clear break by closing below point F, point F is formed by drawing a horizontal line from point C.
Double top pattern forex trading
Picture C illustrates the trading method of the double top pattern. The trader may not be able to identify the double top pattern until points A, C, and B are formed. At point B there may not be any indication that the prices had formed the pattern, since from point B price may continue to move higher in the direction of the existing trend. But the inability of the prices to make a new high, higher than point A and the subsequent drop in the prices may provide a hint of the formation of a pattern.
Once the trader finds the prices going lower than point E, the trader gets ready for price reversal and prepares a trading plan in advance, if the pattern is confirmed later. The prices should make a clear break of the neckline, with prices closing below the neckline and effectively confirming the completion of the reversal pattern. Some traders enter the market with a SELL trade immediately once the prices make a close below the neckline.
However, top traders will wait for the price to retest the neckline and avoid any false breakouts. At point G prices tried to break above the neckline, the failure makes the trader place the order. The stop loss is placed above point B, and the take profit can be calculated as twice the risk to achieve a risk-reward ratio of 1:2
Double top pattern intraday trading
Intraday traders can also benefit from double pattern trading as the pattern is formed in all time frames and can be traded successfully. However, the pattern may take a longer time for completion in the higher time frame charts making intraday traders focus on patterns found in the lower time frame charts only.
Double Bottom Pattern forex trading
The double bottom pattern is a reversal pattern similar to the double top pattern. In the above picture, prices were in a downtrend until the price reached a low at point A and bounced back to C. At point C prices then stalled and went again lower to reach point B, which was equal to the previous low A. Prices failed to move lower beyond A and reversed direction reaching midpoint E. Midpoint E is measured as half the distance between A and C . As prices continued to move higher it broke the neckline at point F. The pattern is completed once prices closed above point F.
How to trade double bottom pattern:
The above picture shows the trade setup of a double bottom pattern. The initial pattern is setup once bottom A, neckline C, and bottom B are formed. However, the pattern becomes identifiable by the trader once the prices pull back from the bottom B and reach point D. At point D the trader prepares a trading plan to be executed if the pattern completes and becomes tradeable.
Once prices move higher than point E the pattern is confirmed but it’s highly recommended to wait for a retracement and to confirm the price reversal before placing a trade. At point F prices came back to test the support (support and resistance forex) and bounces back, the failure of the price to break lower provides the trader with the best entry point. Stop-loss is placed at the low point B and stop loss is calculated as double to risk.
Double bottom pattern meaning:
The price movements during double bottom mean that the prices reached the lowest prices twice and failed, this implies the weakness of the sellers or the strength of the buyers eventually resulting in the reversal of the current trend.
Chart patterns reveal the underlying market sentiment of the buyers and sellers. The trader intends to identify the direction of the price movement and also the best entry point by these charts.
The above picture illustrates the change in the market sentiment and the underlying shift during the stages of the pattern. The prices were in a downtrend initially with sellers in control of the market, once price reached the bottom the selling pressure was waning and the buyers started to gain control and pushed the prices higher. The sellers however gained control and dragged the price lower. The failure of the sellers to make lower prices made the buyers come back, buyers brought the price higher and confirmed their strength by breaking the neckline with the closing of prices above the neckline. The sellers made one more attempt to bring back the prices lower and were unable as the neckline provided support for the buyers. After that final failed attempt by the seller, the buyers took control and brought the prices higher.
Using additional confirmations
It is always in the best interest of the trader to look for additional confirmation before placing the trade. Successful traders make decisions when there is a confluence of multiple methods. In the above picture of the double bottom pattern, the pin bar reversal candle signaled the price reversal during the seller’s attempt to push the prices lower. The longer wick of the candle of the pin bar shows the weakness of the sellers and the ability of the buyers to push the prices higher and also close the prices on a higher note.
The pin bar candlestick pattern would have alerted the trader of an impending reversal of direction well advance of the completion of the double bottom pattern, the confirmation from the candlestick pattern further strengthens the decision of the trader.
Successful traders always use the confluence of indicators, they check multiple indicators to identify and confirm the outcome of one indicator with the other. The above picture shows a double top in the price chart window and RSI in the indicator chart window.
The price chart shows prices making a new high at point A, the RSI in the chart window correspondingly makes a high at point C. The prices make the second high at point B but the RSI makes a high at D which is lower than the previous high of C, the RSI shows a waning momentum in the price action trading and subsequently moves lower. The RSI confirms the presence of weakness in buying pressure at the second high.
A variety of technical indicators can be used to measure different parameters of technical analysis in conjunction with price action to provide much better entry signals and an overall trade plan with a higher degree of success.
Further read: RSI Forex Indicator
Different ways to trade the pattern
Picture I shows different entry points and methods to trade the double bottom pattern, however, many traders use them at their discretion depending upon their risk appetite and also their risk reward ratio.
The earliest trading opportunity is entry at the midpoint A, at this point, the pattern would not have been completed itself, but the trader anticipates it upon seeing the double bottom and the reversal candle from the second low. The trade has a high risk as the pattern has not been completed yet, however, the reward is higher if the reversal completes.
The next entry opportunity is at the break of the neckline at point B, at this point, the pattern has completed itself, traders use the completion of the pattern as confirmation. However, the trade may fail as the neckline break may be a false breakout.
The final and the best entry opportunity of the pattern is at point C, at this point, the price would have completed the pattern, to further avoid a false break out the trader waits for the price to break the neckline and clear the line. The reversal is further confirmed once the price failed to reverse the trendline during the pullback.
Triple Bottom Pattern
The above image illustrates the triple bottom pattern, the pattern is similar to the double bottom except that it forms one more low. The sellers bring the price down the third time and fail, this itself provides a clear understanding of the underlying weakness of the sellers and the strength of the buyers. Many traders start trading the pattern at the neckline breakout and others wait for the pullback to get a better entry price.
Triple Top Pattern
Picture K shows a triple top pattern, which is similar to the triple bottom pattern. The triple top pattern completes itself on the neckline is broken. It has similar entry conditions to the double top.
Limitations
Double top and double bottom patterns are also prone to failures like any other chart patterns. The most important of them is the false break out of the neckline. Price tends to break the neckline only to retrace back and continue moving in the direction of the previous trend. Many traders jump into the trade in a neckline break, instead of waiting for the prices to pull back and retest the neckline.
The tops and bottoms in the patterns are not uniform and do not present themselves in pre-defined shapes. They come in slight variations depending on the market volatility, price momentum, and the time of the occurrence of the pattern. Many traders may not identify properly or even fail to identify.
In an attempt to capture more profits many traders enter the pattern at the midpoint, the halfway point between the neckline and the highest top point, even before the pattern has been completed.
The patterns do not provide a take profit point, they are calculated using other technical tools or risk management tools.
Conclusion:
Most successful traders master a few reliable patterns and continue to trade them successfully, with more practice they tend to be precise in entry and exit. Double top pattern and double bottom pattern are the most important and frequently occurring chart patterns that are worth mastering.
