Double Tops and Bottoms
Waiting for the Setup to Complete Results
in Profits
There are various chart patterns that help us find good reversal candidates.
Of the major reversal patterns, the double top or bottom is not only one of
the most recognizable, but also one of the most predictive.
For our example, we will
discuss a double top, but the rules apply inversely to a double bottom. A
double top forms after a major trend. It is easily recognized as it forms an
"M" at the top of a chart (or in the case of a double bottom, a
"W"). When we analyze a chart that appears to give us a double top
formation, it is important to remember the following rules:
1. The first top is the
highest point of the current trend. Price retreats to form a valley, and then
runs up again towards the first top.
2. When price forms a second top, we are still waiting for the setup of this
pattern to be completed. A double top must move through the valley before we
can consider taking a low risk short position.
3. Ideally, we want to see volume increase as the price falls through the
support level established by the valley. Acceleration in the price's descent
is also preferable. Remember, the more confirmation factors that you have in
your favor, the better your odds of a winning trade.
Once price penetrates the
valley of this M formation, we not only have our entry signal, but our loss
stop and profit target are built into the pattern. The support that was
created by the valley now acts as resistance, and we can set a stop just
above this level to minimize losses should it reverse again. Measuring the
distance from the peaks to the valley, and then applying that measurement
from the broken support level downward can derive our profit target. This is
illustrated in the chart for BCR.
The most common mistake
made is to jump too early on a potential double top or bottom. Unless price
breaks through the support created by the valley (in the case of a double
top), we could be merely looking at a period of consolidation occurring.
Improve your odds of entering a winning trade by allowing the setup of this
formation to complete before "pulling the trigger".
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Big move after pirce
breaks support for RJR.
THC retraces to the
new resistance level befor realizing the profit target.
The profit target
calcualtion is built into the chart pattern when double tops occur.
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