Technical analysts often apply trading double tops as an indicator to spot possible upswing reversals. When an asset’s price makes two successive peaks at almost the same level, followed by a decrease, this is known as a double top pattern.
How to Trade Double Tops | Source: Pookpiik Via Istockphoto
Here’s a step-by-step guide on how to trade double tops:
1. Determine the Pattern:
To trade double tops, search for a significant upward trend in the asset’s price. Price increases lead to the formation of a peak, or the initial top, and a brief decline. The price then increases once more to create a second peak, which typically occurs at a level that is comparable to the original peak. This forms a pattern that looks like the letter “M.”
2. Confirmation:
Examine the volume and price movements to verify the double-top pattern. The pattern is validated by the noticeable spike in selling pressure that occurred during the creation of the second peak.
3. Support Level:
Determine the position between the two peaks that is the lowest, or the support level. This level serves as an essential area of support. Should the price drop below this threshold, it will reinforce the validity of the double-top pattern
4. Entry Point:
As soon as the price falls below the support level, initiate a short position. This supports the pattern and raises the possibility of a trend reversal. To ensure confirmation of the breakout, some traders would rather hold off on entering the trade until a retest of the broken support level.
5. Stop Loss:
Position a stop-loss order somewhat above the second peak, above the most recent swing high. This keeps the upward trajectory going and helps reduce losses in the event that the price reverses.
6. Target Price:
Based on the separation between the peaks and the support level, establish a target price. Subtract the vertical distance from the breakout point by measuring the distance between the tallest peak and the support level. This gives an approximation of the possible downward shift.
7. Risk Management:
Size your position according to your risk tolerance and the distance to your stop-loss level to effectively manage your risk.
8. Trade Monitoring:
Keep an eye out for indications of pattern invalidation or reversal in the trade. If the price action changes, you should adjust your take-profit or stop-loss settings.
9. Take into Account Additional Confirmation:
Although double tops are dependable reversal patterns on their own, you should think about applying other technical indicators or chart patterns, such as bearish divergences, trendline breaks, or other reversal patterns, to bolster your trading decision.
Typical Errors in Double-Top Reversals
Preventing Premature Trading Decisions
One typical error is to begin trades too soon, prior to the level of resistance at the trough being broken. Only when this level is broken does a double-top reversal become confirmed. Long-term price action frequently exhibits several top patterns; therefore, it’s imperative to be patient and wait for an unmistakable break of the trough resistance.
Conclusion
Recall that trading double tops entails risk, just like any other trading technique, so it’s invaluable to always integrate technical analysis with risk management ideas and market knowledge. Furthermore, not every double-top pattern indicates a trend reversal, so you need to be alert and adaptable in your trading strategy.
