What Is a Double Top Pattern?
A Double Top is a bearish reversal pattern typically found on candlestick charts. As the name implies, the double top pattern consists of two consecutive peaks that have similar heights with a minor pullback down to a neckline, support, in between the peaks. It is confirmed once the asset’s price falls below a support level equal to the low between the two prior highs. It is not as easy to spot as you would think because there needs to be a confirmation with a break below support.
Example of a Double Top
What Does the Double Top Signal?
The Double Top signals a trend change from bullish to bearish. Many Double Top reversals can form along the way up, but until the key support (neckline) is broken, a reversal cannot be confirmed. Here are the 8 key points that signal a Double Top:
- Prior Trend: With any reversal pattern, there must be an existing trend to reverse. In the case of the Double Top reversal, a significant uptrend of several months should be in place.
- First Peak: The first peak should mark he highest point of the current trend. As such, the first peak is fairly normal and the uptrend is not in jeopardy
- Trough: After the first peak, there is a sharp decline in price, with a % that varies from every pattern.
- Second Peak: The advance off the lows usually occurs with low volume and meets resistance from the previous high. Resistance from the previous high should be expected. Even after meeting resistance, only the possibility of a Double Top exists. The pattern still needs to be confirmed. The time frame between peaks can vary anywhere on any time frame. It’s hard to give a time frame for it. While exact peaks are preferable, there is some leeway. Usually, a peak tends to end up within 3% of its previous high.
- Decline from Peak: The subsequent decline from the second peak should witness an expansion in volume and/or an accelerated descent, perhaps marked with a gap or two. Such a decline shows that the forces of demand are weaker than supply and a support test is imminent.
- Support Break: Even after trading down to the neckline, level of support, the Double Top reversal is still not complete. Breaking down below the level of support, the lowest point between the peak completes the reversal. This should occur with an increase in volume and a sharp decline.
- Support Turned Resistance: Broken support becomes potential resistance and there is sometimes a test of this newfound resistance level with a relief rally. This is a second chance to exit a long position or open a short.
- Price Target: The distance from the neckline to the peak can be subtracted from the support break for a price target. This would conclude that the bigger the formation is, the larger the potential decline.
Trading a Double Top Pattern
No chart pattern is more common than the double top and the double bottom pattern. This pattern appears so often that other patterns are based off of these two such as triple tops and head & shoulders.
The Double Top pattern is identified on this Bitcoin chart from the bull run of summer 2019 when the price per Bitcoin wicked a little over $13,000. The price found a high (forming a singular top) before coming down towards a level of support (neckline). From here, the price of Bitcoin reversed back upwards to create a similar high (second top forming the double top) and then the double top was confirmed after the breakout back down below the neckline.
Another example of a double top is on the TSLA chart heading into the coronavirus of 2020. Tesla on the after-earnings play shot up towards $190 (after-split) forming a top. From here, TSLA sold off a bit until it found reversal off of support (neckline) and then proceeded to head upwards until it formed a similar high to the previous. The double top was confirmed after the price of Tesla closed below the neckline, signaling a continuation of bearish momentum in the market.
Differences Between the Double Top and Double Bottom
Although there are many criteria that show similarities between the two, they represent the exact opposite in terms of bullish / bearish reversal patterns. The Double Top signals a potential reversal to the downside, after forming two local highs. On the other hand, the Double Bottom signals a potential reversal to the upside, after forming two local lows. When a double top pattern is formed, take a mental note that the bears have overtaken the bulls and you should start looking for a short position. When a double bottom is formed, take a mental note that the bulls have overtaken the bears and you should start looking for a long position.
Limitations of Double Tops
Double Top patterns are highly effective when they are identified correctly. Almost any pattern you can think of: head & shoulders, triple peak, etc. they are all deviations of a Double Top. These patterns are game-changers when you know how to use them, but with any game-changing pattern they come with limitations. Don’t automatically default to the conclusion that there are two peaks that are similar in height and write it off as a Double Top. These patterns can very well have fractals inside the pattern such as an ascending triangle that pushes the price of the asset above the previous highs. Another great criticism of trading technical patterns is that these setups always look obvious in hindsight but that executing them in real time is actually very difficult.