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PTMC team 28.09 2015

Trading with reversal patterns "Double top/Double bottom" in the Protrader platform

Hey there, Protraders!

Continuing the topic about the Price action in Protrader, in current article we will consider another interesting tool that is successfully used by many traders. It is a pattern of the graphical analysis – "Double top". There is the opposite type of the pattern called "Double bottom", in which the methods of analysis and trading are identical to the pattern "Double top". The name of the pattern fully reflects its essence, so to find this pattern on the price chart is not very difficult. But, despite its simplicity, to work with this pattern is not as easy as it seems at first glance.

general scheme of double top and double bottom

What is the pattern of "Double Top"?

This formation is a reversal figure that is formed on the top of an upward trend. The occurrence reason of such pattern is that price cannot break through and entrench on the price level, since limit orders of major market participants are set on it. Thus, major orders are formed on the level of double top, and volume is gradually accumulated before the next impulsive movement. Therefore, this pattern is one of the strongest, which indicates the change in trends of any time horizon.

The structure of the pattern is easy enough and determined by two clearly defined tops, which are located at the same level. Sometimes the situations arise when second top is formed slightly higher or lower relative to the first top. Such variations of the pattern are also correct. The completion of the pattern is considered a breakthrough by the price of a local minimum.

To work correctly with the pattern, it is necessary to satisfy certain conditions:

  • Distance between the tops should not be too large, and not too small, i.e. tops should not just go one by one. For example, the minimal number of bars between the tops can be 8-10.
  • The strength of the pattern becomes more significant, if its tops are on the level of support/resistance. Moving average, Fibonacci grid, and PPZ will help a beginner to define these zones.

On the example of EUR/USD chart, we have allocated two patterns, one of which was not formed until the end, i.e. the price failed to break its local minimum. In this case, the price continued its upward trend. The price has broken a local minimum in the second pattern, confirming the trend reversal.

double top pattern on chart

Some traders are trying to be proactive, i.e. enter the trade not after the confirmation of the classical pattern, but much earlier.For example, after the rollback from the second top on the half size of the wave "2-3".Such tactic can be applied only if there are additional confirmative signals and indicators. Otherwise, the trades most often will be ended with a loss.

As we can see, the "Double top" pattern is very similar to some of the previously described Gartley patterns. The only difference is that all the attention should be paid to the formation of tops, and not to the size of corrections and ratio of the pattern's waves.

Peculiarities of the correct formation of the "Double Top" pattern

  1. The trend. Before the change in trend, it is necessary to have an existing trend. In the case of "Double top", clearly indicated trend is the first criterion of the pattern formation.
  2. The first top. The pattern will be more effective when the first top is the maximum point of the trend, while the second top is slightly lower than the first. Herewith, often occur the situations when the second peak is higher than the first. This is due to the fact, that major market participants create a false breakthrough as though showing a continuation of the trend. Such a breakthrough executes limit Buy orders, which were placed behind the level of first top by less experienced market participants.
  3. The correction. Completion of the correctional wave is calculated when the price approaches to the level of the first top. After the correction has already determined, we hold so-called "neck line" of the pattern through its minimum value. Breakthrough of this line by the price will indicate on the completion of the pattern formation.
  4. The second top. This item is a key one, which determines whether "Double top" will be formed or not, or it will be a different pattern. An important feature is that two tops are located approximately at the same level, herewith minor deviations from the first top are allowed.
  5. Decline after the second top. The subsequent decline is not yet a precise indication of the pattern formation, but only preliminarilyindicates that pattern "Double top" is formed.
  6. Breakthrough of the support level. If the price cannot break through the level that was marked as the completion of the correction, the pattern cannot be called complete. Sometimes, the price can rebound from the support level and stay in the range between top and bottom level (please, see the picture below), forming a more complex pattern, as a "Triple top".
  7. Confirmation of the breakthrough. In order to avoid a false signal to enter the trade, it is important to wait for the confirmation of the signal, the so-called level test, when the price returns to the previously broken level.

How to trade correctly with the "Double Top" pattern?

There are several approaches when trading with this pattern. Let’s consider them in order:

  • The most common method is a breakthrough of the correction level (or the neck level of the pattern), herewith the entrance in the trade is executed after closing of the breakdown bar above this level. General scheme of such approach is shown on the picture below. It is better to place a Stop loss above the pattern's top, taking into account the individual risk management. In the case if Stop loss size exceeds the specified level of risk, then it is better to abandon such a trade.
  • Another option of the pattern trading is to wait for confirmation of the level breakthrough. In this case, the price should return to the previously broken level, as though showing its securing (support becomes resistance). Usually the entrance to the trade is executed by limit order that is placed a few points above this level. Stop loss is also set above the pattern top, which can be later re-set lower after the price going off to the supposed side.

how to trade double top

As for the profit fixation, the original purpose for all the variants is calculated based on the distance between the correction level and top of the pattern with maximum value. Position can be closed fully or partially at the discretion of the trader, on the assumption of the expectation of further price decline.

Use of the "Double Top" tool in Protrader

An automatic searching tool for the "Double top" pattern, which allows finding quickly the pattern based on the specified parameters is implemented in the Protrader trading terminal. These settings have a lot in common with the settings of PPZ tool, considering the similar specifics of both tools. On the NZD/USD chart, we allocated the area by two vertical lines between which the tool has found and marked patterns with the corresponding colors.

double top in Protrader

Trader can set all the needed parameters in the tool settings panel for the correct search of the patterns. Herewith these settings should be chosen, taking into account the individual features of the trading instrument – volatility (Average daily size of the movement), time of the maximal trading activity (European or Asian session).

double top and double bottom settings

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