Double top is a popular reversal chart pattern indicating the end of an uptrend and the start of a downtrend. As the name suggests, the pattern is identified when the price forms two peaks of (almost) the same height. Double top formation is also known as ‘M – pattern’ and is usually easy to find.
The requirements of double top chart pattern include:
- The pattern should form at the top of an extended uptrend.
- The price should form two peaks of almost identical height; and the peaks should be separated by a distinct trough. The lowest point of this trough is known as reaction low or confirmation point.
- The volume should decline as the pattern forms; but the formations of peaks are associated with increase in trading volume. Usually the first top formation has more volume than the second one.
- The pattern is confirmed when the price crosses below the reaction low after forming second top. Volume tends to expand on this price breakout.
Double top chart pattern is a clear indication of the uptrend weakening. The prices are at overbought levels at the first peak and tend to fall from there. This fall or some other fundamental or news factors trigger the price to move up to form the second peak. But the price does not move much beyond the first peak and will fall from there after testing this resistance level.
Traders should short only after confirmation of trend reversal. The immediate price target is derived by subtracting the vertical distance from the reaction low to the first peak, from the breakout point.
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