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Saturday, May 9, 2009

DOUBLE TOP PATTERN – Part 1: Formation

Double Tops Pattern is a bearish reversal pattern that normally forms after an extended uptrend, which marks a shift in trend from bullish to bearish.
Sometimes, this pattern is called “M pattern” because it looks like one.

The Formation of Double Top Pattern

Double Top Pattern contains two consecutive, distinct peaks / tops at about the same price level, with a moderate trough between the peaks.
This pattern forms when the price is in an existing uptrend. It occurs when the price increases to a resistance level (forming the 1st peak), then decline (forming the trough), and then return to the resistance level again (forming the 2nd peak) before subsequently decline further.

The peaks / tops can be either sharp & narrow or a bit rounded looking & wider.
Although the price peaks do not necessarily need to be exactly the same, but it should appear near the same price level.

The pattern is completed and confirmed when the price declines and closes below the lowest point of the trough in between the 2 peaks, which serves as the key support level in this pattern. This lowest point is called the “Confirmation Point”.

This pattern occurs because the buyers are trying to push the price higher, but are not able to do so as they are facing resistance, which prevents the continuation of the uptrend. Then they try to make a second attempt to drive the price higher again, but still fail. In the end, the buyers in the market have dried up & exhausted, and the sellers begin to be more aggressive to take control of the market and drive the price lower, sending it down into a new downtrend.

Double Top Deception
Although Double Top is viewed as a common pattern and quite easy to identify, it’s actually not the case. Many people have actually incorrectly identified patterns that look like “M” shape as Double Top, but in fact it is not a Double Top formation.
Actually, this pattern can be quite difficult to identify correctly. Even when a pattern follows the characteristics of a Double Top, the failure rate is still high particularly when one never waits for the breakout. However, one waits for the breakout through the Confirmation Point, the failure rate would be considerably lower.

Therefore, one should pay close attention & take proper steps to analyze the characteristics of Double Top in order to minimize / avoid deceptive Double Top.
Some important characteristics of a Double Top that need to be paid more attention are the duration / time taken to develop the formation, the depth of the trough, the volume during the formation of the pattern, and the breakout from the Confirmation Point

All these characteristics will be discussed in more detail in the next post.

Continue to Part 2: Important Characteristics of Double Top pattern.

To find out more about other Chart Patterns, please refer to:
Learning Charts Patterns

Analysis Tool:
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Related Topics:
* Learning Candlestick Charts
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2

Useful Learning Resource:
This video has been available for free for quite some time already, and hence, like what has happened previously, it may not be offered for free anymore anytime soon. So, if you’re interested to learn from it, don’t delay anymore to watch it.

Update as at 22 May 09:
Effective from 18 May 09, the above video is no longer available for free.
Sorry if you've missed this opportunity. However, I'll update you again when there are new free trading educational videos. Hope you won't miss the chance to learn from trading experts for free anymore next time.