How to trade double tops and double bottoms

What is a double top pattern?

The double top pattern is a bearish reversal pattern that forms after a prolonged bullish trend. It’s characterised by two distinct peaks reaching a similar high, separated by a retracement back to a support level known as the ‘neckline’. An M-shape is formed in the process.

After the initial bullish surge that creates the first peak, the price will pull back to this neckline support. The price will then make a second attempt at breaching the previous high. However, if the price is only able to rise to a similar (but lower) level as the first attempt, and begins to reverse lower, breaking below the neckline, then a double top pattern has been formed.

The key aspect of the double top is that the second peak shouldn’t exceed the height of the first peak. If it does, the pattern is considered invalidated. When the neckline is convincingly breached on the decline, it triggers a bearish momentum shift, with the price expected to continue declining for a medium to long-term period.

Learn more about support and resistance levels

Traders will often look to open short positions around the second peak, anticipating the bearish reversal (refer to the red arrow in the next chart) the double top pattern suggests. 

What do double top patterns tell traders?

Double top trading patterns tell traders of a potential trend reversal.

Traders often use the height of the pattern to calculate a projected price target for the reversal. The distance from the valley to the peaks can be used to estimate the potential downside move.

Double tops can be a valuable tool in a trader's arsenal, as they can help identify potential areas of resistance and guide decision-making. However, it's important to remember that no single pattern is a guarantee of future price movement. Traders should always consider the broader market context, use multiple forms of analysis, and manage risks effectively.

What is a double bottom pattern?

A double bottom pattern is a bullish reversal formation that emerges after a prolonged downtrend. It consists of two distinct lows that reach a similar level, separated by a rebound back to a key resistance area known as the ‘neckline’. A W-shape is formed in the process.

After the initial bearish descent that forms the first low, the price will bounce back up to test this neckline resistance. Following this, the price will make a second attempt at breaching the previous low. However, if the second low fails to surpass the initial low and instead reverses higher, breaking above the neckline, then a double bottom pattern has been formed.

Like the double top, the key aspect of a double bottom is that the second low shouldn’t exceed the depth of the first low – if it does, the double bottom pattern is considered invalidated. Once the neckline is convincingly breached on the rebound, it triggers a bullish momentum shift, with the price expected to continue climbing for the medium to long-term period.

Traders will often look to enter long positions around the second low, capitalising on the bullish reversal the double bottom pattern suggests. 

What do double bottom patterns tell traders?

Double bottom trading patterns tell traders of a potential bullish reversal after a prolonged downtrend.

Traders closely watch for this pattern because it suggests that the selling pressure is waning and the bulls are regaining their footing. The depth of the double bottom can also be used to estimate a potential price target for the anticipated upside move.

While no single technical pattern is a guarantee of future price action, the double bottom can be a valuable tool in a trader's arsenal. By identifying these formations and understanding their implications, traders can gain valuable insights to inform their decision-making and position-taking.

As with the double top pattern and other technical charts and indicators, it’s important that traders know that the double bottom pattern is just one piece of the puzzle. It’s crucial for traders to employ a multi-faceted approach, using the double bottom in conjunction with other technical indicators (including the double top pattern), fundamental analysis, and overall market context.

Learn about other popular chart trading patterns

Incorporating these patterns into a broader technical and fundamental analysis approach can help traders navigate the markets more effectively while managing the inherent risks.

As with any technical analysis tool, the double top and bottom should be used in conjunction with a comprehensive trading strategy, not as a standalone decision-making framework.

Prudent traders understand the benefits these patterns can offer, while remaining cognisant of their limitations.

How to trade on double tops and double bottoms

There are two main approaches to trading double top and double bottom patterns:

In a double top formation, traders may consider a short position after the second peak is confirmed. Conversely, in a double bottom pattern, traders could look to open a long position following the validation of the second low.

Using additional technical indicators, such as the Relative Strength Index (RSI) or the Parabolic SAR can help confirm trading signals. These momentum-based tools are often used to strengthen the reliability of the double top and bottom patterns, potentially reducing the risk of false breakouts (or fakeouts).

Contracts for difference (CFDs) are commonly used to trade on these reversal patterns, as they enable traders to go both long and short. With a CFD trading account, traders can get exposure to double tops by opening a bearish position, and double bottoms by opening a bullish position.

In a double top scenario, a short CFD trading position may be initiated after the second peak. This approach is based on the prediction that selling pressure will increase and the price will decline following the failed attempt to break above the resistance level.

Conversely, in a double bottom pattern, going long with CFDs once the neckline is convincingly breached may enable traders to ride the anticipated bullish reversal. The second low failing to undercut the first one is a strong signal that the selling pressure may be waning.

Below is a step-by-side guideline on how to trade double top or double bottom patterns:

1. Decide if trading CFDs is the right choice for you
2. Research the markets available for trading
3. Learn how to identify double tops and double bottoms
4. Practise trading with a demo account
5. Create a live CFD trading account when you’re ready to trade the live markets

Double top trading example

Let's examine a real-world example of how to trade a double top formation. The price graph shows an overall bullish trend before the first peak. However, the upward momentum stalls at this initial peak, and the price retraces down to the neckline support.

If the downward momentum had continued to break the neckline, the pattern would’ve been invalidated. But instead, the price bounced off the neckline and resumed its bullish trajectory – though only briefly. Soon, the asset lost momentum once more, and this time the retracement successfully breached the neckline, signalling a more permanent reversal in the overall trend.

In this scenario, a trader could consider opening a short position at the height of the second peak, before the pattern is fully confirmed. They’d then look to exit the short trade at the first signs of the trend turning bullish again. To mitigate risk, traders can utilise stop-loss orders, including guaranteed stops, to protect against potential losses if the market continues to rise after the second peak.

By understanding the nuances of the double top pattern and employing robust risk management techniques, traders can navigate these reversal signals with greater confidence and potentially capture attractive returns. Although it's important to note that all trading involves risk. Explore the educational resources at IG Academy to learn more.

Double bottom trading example

Now, let’s take a look at a double bottom formation and how traders can leverage it for potential gains. The price graph shows a clear bearish trend leading up to the pattern. At the first low, the downward momentum stalls and the price retraces back up to the neckline support level.

If the upward momentum had continued to break the neckline, the double bottom pattern would’ve been invalidated. Instead, the price bounced off the neckline and resumed the overall bearish trend before establishing the second low. This second low marks a more permanent reversal in the trend, as the price subsequently breaks through the neckline resistance and continues its ascent.

In this scenario, a trader could consider opening a long position at the second low, aiming to capture the bullish reversal. They’d then look to exit the long trade at the first signs of the trend turning bearish again. To manage risk, traders can utilise stop-loss orders to protect against potential losses if the market continues to fall after the second low.

By understanding the dynamics of the double bottom pattern and employing effective risk management strategies, traders can navigate these reversal signals with greater confidence and potentially realise attractive returns. Visit IG Academy to learn more.

Double tops and double bottoms in trading summed up

• Double tops and bottoms are powerful trading patterns that signal potential shifts in market direction from bearish to bullish, or vice versa
• For a double top, traders open short positions at the second peak, anticipating a bearish reversal if the neckline is convincingly breached
• In a double bottom, traders look to enter long positions at the second low, aiming to capitalise on the anticipated bullish momentum
• Pattern confirmation requires the price to break through the neckline support/resistance - without this, the formation is considered void
• Integrating double tops and bottoms into a comprehensive trading strategy can help identify high-probability opportunities to profit from trend reversals
• Prudent risk management is crucial when trading these patterns, as false signals and market volatility can impact their reliability