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Double Tops and Double Bottoms are one of the most commonly recognized patterns in technical analysis. Whatever your style of trading, it is likely that you have come across these patterns from time to time.
However, if most traders are aware of Double Tops and Double Bottoms, and we know that the majority of traders do not succeed in the markets, what importance should we place on a Double Top or Double Bottom formation when we see one?
A suggestion I make to a lot of students is to find a pattern, such as Double Tops and Double Bottoms, then go back to lots of different charts, on lots of different time frames, and look only at this one pattern working.
This will give you an idea of the frequency of these patterns, the success rate of these patterns, and the best way to trade these patterns on your markets.
Looking at Double Tops, we have seen a potential setup come in recently on the US Dollar / Japanese Yen currency pair (FXUSJY in ProfitSource). Chart 1 below shows this setup.
Chart 1
click chart for more detail
The first thing that should strike you about this setup is that the market spent about three times as long running up into the second top, as it did running down from the first top.
This would tell us that there is some strength to the upside in this market. Not what we want to see when we are looking for a short trade!
However, further analysis shows us that this double top has formed on a strong resistance level. We have heard the adage that old support levels become new resistance levels, and in this case, our support level of around 108.60 has now become a potential resistance level for our Double Top. Chart 2 below shows how this level, which gave us Double Bottoms in 2005 and 2006, is now potentially giving us Double Tops in 2008.
Chart 2
click chart for more detail
Finally, Safety in the Market students who have studied their Number One Trading Plan manual would be aware that the current prices of the Double Tops (108.61 and 108.59) are very close to 7/8ths or 87.5% of the price of the June 22, 2007 high of 124.15. I would encourage all students to revisit this section of the manual, and look for the next important level to watch on the way down.
Double Tops and Double Bottoms are widely traded as stand alone setups, but it pays to use them in conjunction with other technical analysis techniques. The work I have done above is taken from Safety in the Market education courses, but you could also look at using Elliott Wave analysis to back up your Double Top or Double Bottom patterns. Or, you could use a MACD or Moving Average Crossover as confirmation before looking to enter a trade based on one of these patterns.
Remember to stick to your trading plan, and always manage your risk. Whatever technique or setup you use to make money, if you cut your losses short, you’ll be around long enough to reap the rewards when you are right.
Be Prepared!
Mathew Barnes
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