Monday, June 10, 2013
Double top reversal chart pattern
This is continuation of my article series on chart patterns. Last time I discussed bullish reversal pattern: double bottom. What could I do today if not discuss bearish reversal pattern: double top? Like any other technical structure it can be found of various time frames and all of them can be both valid and fake. Everything depends on whether the pattern is broken in the direction it should break. A reversal pattern should change a current trend and continuation pattern should be broken in the direction of a current trend after consolidation period is over. As double top is a bearish pattern it means that an upward trend is about to end and bears will show their strength soon. Let us look at some necessary conditions that have to be that we might state that the picture we see is a valid double top pattern.
Key components in double bottom pattern
As it is a reversal pattern the first thing that there has to be is a previous uptrend. The security had to go up for some time in order for the pattern we are discussing to be formed. Depending on the structure the uptrend could have been from a few days (weeks, months) to a year and even more.
There has to be the first sharp rise that marks the first spot in the top or peak. It is known as the highest point in the current uptrend. At this point we cannot say whether the tendency has changed or not as there still isn’t any indication of a reversal and increase in supply.
The first sharp fall! Reaching the first top the price of the security crashes. It indicates that smart money is distributing the security and it is good time to sell it short and so selling starts. After some time (hours, days or even weeks) the first bottom (or important support) is formed.
Back to the top! At some point inertia of the bulls kicks in and they continue buying assuming that the uptrend is not over yet. So, the price of the security soars to the first spot of resistance (top) and this time the spot becomes the second spot of a double top pattern.
The second sharp fall! After hitting the first resistance (top) the security starts collapsing, which indicates that there really is serious distribution of the security taking place at current prices. In most cases the prices will reach the first spot in support. Likewise, in most cases the price after hitting the support will go up (rally) a little.
Break of the support. The two points of support that were made as the security fell sharply after reaching the top is finally broken. That is the point where the double top pattern becomes a valid one.
Resistance becomes support. That is a classical rule of technical analysis. It is not a necessity, but a security sometimes comes back to test previous support (that is now resistance) and if the break was not fake the resistance will hold.
Traditional target for the exit of your short trade is the distance from the break point to the highest point of the pattern added to the breakout point. That is the smallest distance that the price is expected to travel. It may go further, or it may fail to reach the expected target. However, if you need some guidelines where to exit this could be one of those. Additionally, you can move your stop above clusters of hourly or daily candles (depending on the strength of reversal).
US dollar index example
US dollar index has been in a clear uptrend for a prolonged period of time. On the 22nd of May it may a strong rally upwards and on the 23rd of May it fell sharply. So we can say that the rally on the 22nd of May formed the first peak (resistance) in the pattern at 10 876 level. The fall formed the first point of support at 10 766.
It then made an attempt to come back to the peak and break it, but the attempts were futile and after failing to make new highs US dollar collapsed to previous support (just a little lower). It then consolidated for a few days. Then the security broke down again jumped back to test previous support, which is now resistance and failing to break that it collapsed.
Watch the video to see for yourselves.
Ok, I will finish now. Be sure to read related articles to learn more on technical analysis. I promise to expand on this in my future posts.
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