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Double Top and Double Bottom

The Double Top and the Double Bottom are price action based technical analysis patterns. The Double Top is trend reversal chart pattern that forms at the end of a market uptrend. The formation is characterized by two consecutive peaks of approximately the same price. The two peaks are separated by a valley. The pattern looks like the letter M. The lowest point of the valley is called the neckline.1)

Double Top Entry

The formation is confirmed when price breaks below the neckline. The move down suggests that the shift signalled by price topping out is a real change in trend. In financial markets that offer volume metrics (fx futures, stock markets, bitcoin exchanges), a low volume on the move up can be a further indication that prices are about to reverse. Because there is no centralized volume stats for the forex market, currency traders can’t use this extra resource to its full potential.

The chart above shows a Double Top on the EUR/USD Weekly charts. Europe’s single currency reached a high of 1.6019 in April 2008. From here, the pair consolidated for the next three months, marking a retracement low of 1.5284 in the process. In July, the common currency staged another rally that saw it retest the 1.60 level. The highest point reached this time was 1.6037. Prices were unable to hold above the 1.60 mark however. In few weeks as the selling intensified, the currency pair broke below the 1.5284 neckline thus confirming the pattern.

The psychology behind the pattern is relatively simple. Buyers were unable to bid up the financial instrument on two separate occasions. Most traders will place their stoploss just below the lowest point marked by the recent price retracement (in other words just below the neckline). Thus when price manages to break this level losses in the currency pair tend to accelerate.

Double Top Stoploss and Takeprofit

When thinking about where to place your stoploss, you should always look for a logical place. The obvious place for a stoploss on a price action pattern is to put it where taking out the SL would mean invalidating the PA pattern itself. For a double top, this would mean a break of the highest high marked by the two tops. In our chart example, this would mean placing the stoploss just above the 1.6037 high. With an entry at 1.5284 and a stoploss at 1.6038 (the high+ 1 pip spread), our total risk on this trade would’ve been 754 pips.

The picture above shows our previous Double Top entry with added SL and potential takeprofit levels. I’ve marked possible TP areas with 1R, 2R, 3R, 4R, and 5R. The ‘’R’’ here stands for the initial risk. In our case, one R= 754 pips. As shown on the chart, after breaking the neckline the EUR/USD moved all the way down to 1.2328 in only three months. There were fundamental reasons behind the fall, the 2008 Financial Crisis was in full swing and the US Dollar was seen as a safe refuge from the chaos. With US financial assets losing value, investors were selling everything for cash thereby propping up the Greenback. The single currency stopped short of hitting the 4R level, it only moved to as low as 1.2328. The 4R figure stood at 1.2268. It took a year and half and a Debt Crisis in the Eurozone for the currency pair to retest and finally break the 4R level in May 2010.

Double Bottom

The Double Bottom is trend reversal pattern that forms at the end of a market downtrend. The formation is characterized by two consecutive troughs of approximately the same price. The two troughs are separated by a peak in the price. The highest point of the valley is called the neckline. The pattern looks like the letter W.

Double Bottom entry, stoploss and takeprofit

The formation is confirmed when price breaks above the neckline. The brakeout to the upside suggests that the shift signalled by price bottoming out is a real change in trend and not a mere fakeout. A low volume on the move down can be a further indication that prices are about to change course.

Similarly to the Double Top formation, the stoploss for the Double Bottom should be placed just beyond the neckline. The triggering of the stoplosses placed above this area will accelerate any move upward.

This GBP/USD Weekly chart shows a Double Bottom. The Pound struggled at the start of 2013 as uncertainty regarding the economic outlook remained. Sterling was starting to ‘’price in’’ the threat of a double dip recession and the charts showed this. In March Cable fell to a low of 1.4830. Few months later, this low was retested but the bulls managed to repel the bears and propelled prices back above 1.50. The Double Bottom formation was confirmed few weeks later when the GBP/USD broke above the 1.5750 neckline.

With a stop just placed just below the 1.4812 low and an entry at 1.5751 (neckline + spread) our total risk on the trade amounted to 939 pips. The fundamental backdrop behind this TA pattern was very interesting. The market had already discounted a worsening of economic conditions earlier in the year. As data started to come in on the high side and the UK economic statistics started to indicate that a genuine recovery was underway, market participants had to reassess their positions. The better than expected figures fuelled trader’s expectations that the Bank of England will have to exit its unconventional easy monetary policy sooner than previously anticipated. This was obviously good news for the Pound, its value skyrocketed in the second half of year, making it the top forex comeback story for 2013.

As we can see on the picture above, at the time this entry was written (February 2014), the Pound has yet to hit the 1R level above the neckline entry at 1.6689. Cable got really close to hitting the first target on January 24th when it rallied as high as 1.6667. The GBP/USD is currently trading 400 pips below 1R at 1.6438. It remains to be seen if the Pound will eventually take out the first target level and continue the move upward.

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