DavidWaring

In our last lesson we learned about the double top and double bottom and how to spot these setups on a stock chart. In this lesson we are going to learn about a common trading strategy that traders use to trade these setups in the futures, forex, and stock markets.

As the double top and double bottom are signs that a financial instrument has failed to break through a certain level (resistance for a double top and support for a double bottom) these chart patterns are considered reversal patterns. As this is the case, traders will commonly look to trade the double top when it occurs at the top of a trend as a sign that the uptrend is reversing, and to trade the double bottom at the bottom of the trend as a sign the downtrend is reversing.

First lets look at the a common trading strategy for the double top. For confirmation that a double top has actually formed and that a reversal in the uptrend is at hand, a common strategy is to look for declining volume going into the second peak and rising volume on a break below the bottom of the trough which has formed between the two peaks (support).

Once these things line up a common trading strategy is to enter the trade on the break of support with a target which is equal to the distance between the bottom of the trough and the top of the two peaks projected downward from the bottom of the trough. The stop order is then placed just above the last peak.

Double Top Example:


For double bottoms the process is a mirror image of the above explanation. The strategy here is to look for declining volume going into the second trough and rising volume on the break of the peak which has formed between the two troughs (resistance). Once you spot the double bottom the trade is entered on the break of resistance with a target which is equal to the distance between the top of the peak and the bottom of the two troughs projected upward. The stop order is then placed just above the last trough.

Double Bottom Example:


We should now have a good understanding of a common strategy used to trade double tops and double bottoms. In or next lessons we are going to look at another common chart pattern which is known as the head and shoulders pattern and a common trading strategy which is used to trade this chart pattern.

Links to Help You Learn About Double Tops

Trading Double Tops and Double Bottoms
Double Tops - Recognia Inc.
Reversal Chart Patterns - Double Top

As always if you have any questions or comments please feel free to leave them in the comments section below, and have a great day!

rocketman7

David,
I found this site a few days ago - this is awesome! I'm starting to work through the lessons, a few each day, and noticed that in the video you say to put the stop for a double bottom just below the second trough but in the text you say to put it just above the second trough. I assume just below is the correct placement. Again, thanks for putting this site together, I'm looking forward to getting through all the material.

rds1933

In the Double Bottom Example, Trade Target has been shown as 174 points that is ten times the gap between the bottom resistence line and the trough line (17.4 points). May it be assumed that the trading target in such a case is ten times normally. In this example, the top achieved is only 346 level giving a gain of only 47 points from the entry point. Now, this is too far from the trade target of 174 points. Please explain this point.

David Waring

Hi rds1933,

Welcome to the community.

Normally a one point move is the smallest move that a financial instrument can make. So with this in mind a move in my example from 17.4 to 17.5 is a one point move. Another way of looking at it would be that a move from 17 to 18 is a 100 point move. So the gap here is 174 points as well as the target.

As to your question about the entry price, the entry price on the chart is 297.4 so the target would be 297.4+17.4 which would equal 314.8. So I think the confusion on this one lies as well with the full move is not 47 points but 470.

Let me know if that does not make sense.

Best Regards,
Dave

rds1933

Thank you so much, Dave
rds1033

jtrani

Hey Dave,

First of all, this site is great.

Anyway, I'm new at this (and a little confused) so I have a question.

So I acknowledge that you that the strategy is to get in on the break, but what are we hoping will occur once we're in?

I was under the impression that we were hoping for the pattern to continue. For example, in a double top situation, we would be entering at the break, which would be the trough of the second and third projected top. We enter a stop loss at the resistance point because we want to cash in on the gains the security has made before the price starts moving downward again. Is this what we are trying to do?

Also, when you refer to volume are you referring to trading volume of the particular security for a specified period of time?

Thanks again for this site.

jtrani

I ask because the chart does not actually go on to follow the pattern.

David Waring

Hi Jtrani,

Thanks for the comment I am glad you like the site and welcome to the community.

You are correct that the goal when trading the double top using the methodology above is for the pattern to continue moving downward to a target which is the distance between the top of the pattern and the bottom.

The stop is placed above the resistance point because in this particular strategy traders want to take your loss there to avoid loosing too much on the trade.

I think the confusion arises here because in the chart that I have posted in the lesson the pattern does not continue. As is the case in this lesson the market will often times not act in the manner that a particular strategy wants.

Hope that helps clarify. If there are any other views on this one please feel free to post them below.

Best Regards,
Dave

marcusfong

Hi David,

Couple of question on Double Top and Double Bottom strategy, can this be use for Options trading? And how many day's chart do u use?

Thanks

Marcus

David Waring

Hi Marcus,

Welcome to the community.

It depends on what you are trying to do with options but yes in some cases this could be used as part of an option trading strategy.

This chart pattern will show up on pretty much any time frame however in general the longer term the chart is that the pattern shows up on the more relevant the pattern is though to be. So for example if this pattern shows up on a daily chart then most traders would consider that more relevant than if the pattern showed up on an hourly chart.

If there are any other comments on this one please feel free to post them in the comments section below.

Best Regards,
Dave