The double top reversal is a chart pattern that indicates an upcoming price reversal for a security.
The defining feature of the double top reversal is the two peaks with a moderate trough between, the second of which will be followed by a sharp downtrend that reverses all the gains leading into the price peaks, and is expected to continue a sharp decline.
Identifying a Double Top Reversal
A true double top reversal pattern is considered to have 6 key features.
• Previous Trend
A double top reversal pattern must have a substantial prior positive trend that lasts for a few months or more.
• First Peak
This first peak should be reached as a gradual continuation of the price’s uptrend. The following reversal should be seen as common profit-taking after a long and gradual increase in price.
The following trough should reach a 10% to 20% decline on low volume and persist for some time.
• Second Peak
The second peak should be reached on a continuation of low volume as the security resumes its climb to the previous peak. The resistance from the first peak does not need to be reached, but the second peak should generally come within 3% of the original peak.
The decline from the second peak should occur rapidly on higher volumes, often with a few gap downs in price to reinforce the strong selling pressure that has emerged after the failure to breach the resistance of the first peak.
• Support Break
The decline of the double top reversal continues with a sharp break through the support provided by the bottom of the trough between the two peaks. The downtrend should continue for some time before a reversal or pause.
Trading a Double Top Reversal
Day traders generally use double top reversals to identify a sharp downward trend lasting a few weeks to a month or more that offers a number of opportunities to make strong short trades against a security.
A double top reversal is not truly confirmed until the sharp reversal from the second peak, which means that most day traders are looking to trade the security as the price breaks through the trough resistance level.
This offers a long opportunity where the general direction of the price is known, which means that day traders can short any upturns with the confidence that they will soon be sharply reversed.
Generally day traders should be using the double top reversal pattern to identify the general trend of the price, and then use short term patterns and indicators that are relevant to long term price downtrends.
Double Top Reversals and Moving Too Early
The main error that traders make when using the double top reversal chart pattern is to place their trades too early before the break through the trough resistance level.
The double top reversal is not truly confirmed until this resistance level is breached, which indicates that the previous increase in price has been completely abandoned and the bulls have capitulated to the bear selling until a new, much lower, resistance level is reached.
This is particularly important because because 3, 4 and even 5 top patterns are very common in long term price action, and only after the trough resistance level is broken can traders be confident that they have identified a true double top reversal pattern.
Day traders may be unaccustomed to using long term chart patterns, such as the double top reversal, but these patterns are extremely useful for identifying long term price trends, with which the day trader can choose the most appropriate short term indicators and patterns to use for making their actual trades.
Traders should be cautious when trading with chart patterns featuring multiple tops, as this is a very common pattern among long term price action, and they should wait until the trough resistance level is broken decisively before trading on the subsequent downtrend in the following weeks.
It can be easy to see chart patterns everywhere, so it is very important to look for the key defining details of specific chart patterns to confirm that the requirements have been met.
Only then can day traders have the confidence in using long term chart patterns, such as the double top reversal, to guide their subsequent trading for that security.