During my visit to the Himachal Mountain ranges, I was captivated by the tranquillity of the place. However, as I spent more time there, I could not help but notice that the unique peaks of the mountains resembled the double-top chart pattern, with their distinct twin summits mirroring the pattern seen in financial charts.

Now, turning our attention from the serene mountain ranges to the world of chart patterns, let us delve into the intriguing concept of the 'double top' chart pattern.

What is a double top chart pattern?

As the name suggests, a double top is a pattern of price movement on the trading chart that represents a major change in trend and a momentum reversal from a prior up move in market trading. It typically looks like the letter “M” in the trading charts.

A double top is a bearish technical reversal pattern that forms after an asset reaches a high price two consecutive times with a moderate decline between the two highs. It is confirmed once the asset's price falls below a support level (generally neckline) equal to the low between the two prior highs.

How to identify double top?

A double top is a bearish reversal pattern in technical analysis, signalling a potential shift from an uptrend to a downtrend. To identify it, first, confirm an ongoing uptrend with consistent price increases. The pattern starts with the left peak, a high point where the asset hits resistance and reverses. Next, a decline creates a trough between the two peaks. Then, the price attempts to revisit the prior high, forming the right peak, often at a similar level. The neckline, connecting through lows, acts as support. Confirmation occurs when the price breaks below the neckline, marking a likely trend reversal. Monitoring volume during these stages can provide additional validation.

An example of a double top pattern could be observed in the below captured daily chart of Wipro Ltd.

In this chart, it could be observed that the double top pattern started building at levels of ~ INR 625 in Aug’21, in Nov’21, the pattern formed first top at levels of ~INR 725, in Nov’21 itself it retested the levels of INR 625 forming the neckline of the pattern, it created the second top in Jan’22 at levels of ~INR 725, this is the most common entry point while some prefer to wait for a pullback or a retest of the neckline after the initial breakout. and rebounded giving a breakout and touched the levels of ~ INR 523.00 in Apr’22.

A common way to estimate a price target is to measure the vertical distance between the highest point of the double top (the first trough or the second trough) and the neckline (distance between 625 & 725). Then, add this measurement to the neckline breakout level to get a potential price target (distance between 625 & 523).

Place your stop-loss below the second bottom, a critical level. If the price drops below this point, it indicates pattern failure and potential further downtrend. Consider a 2:1 risk-to-reward ratio, where the stop-loss is set at half the vertical distance of the target line.

Limitations of the double top pattern:

The double-top pattern is a useful tool in technical analysis, providing insights into potential trend reversals. However, it has limitations. False signals are a common drawback, as not every double top pattern leads to a successful trend reversal; some may be consolidation patterns or continuations of the existing trend, misleading traders. Market conditions also influence its effectiveness; in strong trends, like bullish markets, the double top may be less reliable. Additionally, trader psychology plays a role. Emotions, biases, and decision-making under pressure can impact a trader's ability to identify and act on the pattern accurately. Thus, the double top pattern is valuable but should be used alongside other analysis techniques, considering market conditions and psychological factors.

Conclusion:

In conclusion, while the double-top pattern is a valuable tool for technical analysis, it is not foolproof and has its limitations. It is essential to use the double-top pattern as a complementary tool alongside other forms of analysis to make well-informed trading decisions.

If you are eager to grasp the intricacies of the analysis involved in Double Top patterns and gain insight into the utilization of other essential indicators, be sure to explore my course on Technical Analysis.

Until next time!