Double Top and Bottom Patterns in the Stock Market

Introduction:

Investing or trading and market interpretation go hand-in-hand to give a good point of action. When analyzing the market, fundamental analysis determines the company you plan to invest in. On the other hand, technical analysis forms part of identifying entry and exit points of a trade position. Technical analysis uses numerous ratios and chart patterns (like cup and handle patterns). One of the chart patterns many use is the double top and bottom pattern. 

Let’s briefly study the double bottom and double top chart patterns in this article. 

What is a Candlestick Pattern?

Before discussing the details of the double top and bottom pattern, let’s understand the element’s components that make chart patterns like the rounding bottom pattern: candlesticks. 

Candlestick patterns are a popular tool in financial analysis. They show daily price movements on a candlestick chart, which displays the price of securities, currencies, or derivatives over time. Each candle represents four key points: the open (first trade), high (highest trade), low (lowest trade), and close (last trade).

Candles are either red or green, depending on whether the price rose or fell. A green candle means the closing price is higher than the opening (bullish candle), signaling bullish movement, while a red candle means the opposite (bearish candle), signaling bearish movement.

The candle’s body shows the difference between the opening and closing prices. The body’s length tells traders how strong the market movement was— long red indicates heavy selling and long green means strong buying. 

Candles also have shadows (or wicks), which show the range of prices beyond the body. A long upper shadow suggests the price hit a high but faced selling pressure, while a short one signals a bullish session with steady buying.

 Let’s move on to the topic of discussion— the double top and bottom patterns.

What is a Double Top Chart Pattern?

A double top is a bearish reversal pattern that forms when an asset hits a high price twice, with a slight drop in between. You’ll know it’s confirmed once the price falls below the support level, which is the low point between the two peaks. When that happens, the chart looks like an ‘M.’ 

Spotting a double top isn’t as simple as it sounds, though. The key is waiting for confirmation, which only happens when the price breaks below that support level (the level below which the price doesn’t fall for a certain period). Without that, the pattern isn’t valid yet.

A double-top pattern signals a bearish reversal when it’s complete. Here’s why: First, on the chart, the price hits resistance (a price point above which the price doesn’t increase for a particular period) at a high point and fails to break above it on the second try. Then, the price falls below the previous swing low, creating a new low. This is a key sign of a downtrend. Lower swing lows are common in downtrends, and that’s precisely what a double-top pattern indicates. It shows the market moving away from an uptrend and entering a period of decline. 

What is a Double Bottom Pattern?

A double bottom pattern is a chart pattern that signals a trend reversal in technical analysis. It forms when a stock or index drops, rebounds, drops again to a similar level, and then rebounds again, creating a “W” shape on the chart. 

The low points are seen as support levels. An increased volume during the rebound from these supports strengthens the bullish signal. The double bottom pattern usually follows a downtrend and indicates a potential shift towards an uptrend. 

A double bottom signals a bullish reversal with two key pieces of evidence. First, the price meets the support and fails to make a lower low on the second attempt. Then, it rallies above the previous swing high, forming a new swing high. This is a sign of an uptrend. Higher swing highs mark an uptrend, and that’s exactly what a completed double bottom pattern shows. So, when you see this pattern, it usually means the market is shifting upward. 

How to trade the Double Top Bottom Patterns?

A] Trading with the Double Bottom Pattern:

(Image source- Trading View)

After spotting the double bottom pattern, waiting for confirmation before making a move is crucial. This comes when the price breaks above the peak between the two lows, ideally with higher trading volume, showing strong buying interest. Here’s what you need to do:

• Entry: Once confirmed, you can enter a buy position. Some traders enter immediately after the breakout, while others wait for a pullback to the breakout level for better risk-reward.
• Stop Loss: There’s no fixed rule for stop loss. It depends on your setup—some traders place it below resistance, while others put it under the recent swing low.
• Target: Set your target by measuring the distance from the lowest point of the double bottom to the peak, then add that to the breakout level to estimate your potential gain.

B] Trading with the Double Top Pattern:

(Image source- Trading View)

First, try to confirm the pattern and look for signals like a price drop below the trough between the two peaks, increased volume during the breakdown, or other technical indicators. Once confirmed, follow these steps:

• Entry: Start a short trade after confirmation, ideally when the price drops below the trough. Some traders wait for a pullback to the breakdown level for a better risk-reward ratio.
• Stop Loss: Decide your stop loss based on your setup. Some traders place it above the resistance level or the recent swing high.
• Target: Set your target based on the pattern’s height—the distance between the peak and the trough. As additional targets, you can also use other support levels or Fibonacci retracement levels (tools to identify potential support and resistance levels).

Remember, no tool is solely reliable enough to guarantee gains. So, always manage the risks by sizing your positions according to your risk profile. Club the pattern indications with other technical indicators to trade or invest more precisely. After placing your order, exit your position after hitting the target. 

Possibility of Double Bottom Pattern Pullback:

After a double bottom pattern completes and the price rises above the breakout point, it often pulls back near that point. Knowing this can help in two ways:

• You might expect this pullback if you’re already in a long trade. It helps you decide whether to stay in or exit, depending on whether you believe the price will rise again.
• The pullback offers a new chance to buy for those waiting to enter a long position.

Pullbacks after a double bottom are common and can vary. Sometimes, the price just hits the breakout point again; sometimes, it goes beyond it, and other times, it might not reach it.

Limitations of Double Top and Bottom Patterns:

Double tops and bottoms can be powerful tools if you spot them correctly. But misinterpreting them can be risky. It’s crucial to be careful and patient before making any decisions.

Take double tops, for example. An actual  double top is a strong bearish signal, often leading to a sharp drop in a stock or asset. But don’t rush to conclusions. You must identify the critical support level to confirm it’s a real double top. Just seeing two peaks isn’t enough. If you act solely on that, you might make a false read and exit your position too soon. So, always take your time and verify the pattern properly.

Bottomline:

Double bottom and double top patterns for charts are handy tools in trading. They can help you find entry points, set stop-loss levels, and determine profit targets. But remember, no pattern is perfect. Risk management is key. Do your research and use other indicators and analysis methods to back up your trading decisions. By mastering these patterns and using them as part of a solid strategy, you’ll navigate the Indian stock market more confidently and precisely. You can approach a registered stock market advisor to master chart patterns and interpret indicators.

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