Are you trading the double top or double bottom chart patterns as you expect?
Even if you are doing the textbook “enter when the neckline is breached,” I must say that it is difficult to win consistently just by doing that.
In this article, while taking a detailed look at the collective psychology of the market, I will explain in detail one of the basic patterns of technical analysis, the double top and double bottom, focusing on how to trade with this pattern.
I will proceed with this explanation on the assumption that you have already read the previous article on support and resistance lines. If you have not read it yet, please click on the link below to read it.
Explanation What are Support and Resistance Lines? How to draw them, how to use them
- What are double tops and double bottoms?
- How to trade well with double tops and double bottoms?
- Dissecting the group psychology that arises in a double top
- Growing distrust of trend conditions
- Further distrust after the neckline is breached
- Group psychology begins to tilt toward “reversal”
- However, judging by the Dow Theory, it is still on the upside
- Rebounding at push lows, but mood of reversal strengthens
- Selling forces that had been waiting for an opportunity entered the market in earnest
- In the market, anything can happen
- Thus, the collective psychology finally tilts toward a “market reversal”
- Meaning of Double Top and Double Bottom and How to Trade – Summary
- Preview of next installment
What are double tops and double bottoms?
A double top is a chart pattern formed by two characteristic highs in a row.
A double bottom is a chart pattern formed by two distinctive lows in a row.
Both chart patterns are known as “reversal patterns” that suggest the possibility of a reversal in the opposite direction of the previous price movement.
A double top is a chart pattern that indicates a market situation in which the exchange rate cannot rise any higher, and when a double top is formed, there is a possibility of a subsequent reversal and decline.
A double bottom is the opposite of a double top, which is a chart pattern formed by two distinctive lows.
Likewise, a double bottom is a chart pattern that indicates that the price cannot go any lower and may reverse to the upside.
The Double Top and Double Bottom are very commonly used in technical analysis of currency trading (Forex) and stock trading, and are among the most distinctive chart patterns that attract a lot of attention from market participants.
How to trade well with double tops and double bottoms?
So far, through a number of technical analysis articles, we have explained in detail about trends and ranges, the Dow Theory, and support and resistance lines.
As we have mentioned in these articles, what is important in creating a trading strategy is the market trend (the existence and direction of a trend) and the group psychology that appears in the market trend.
Ignoring the market trend and the collective psychology and simply trading by mechanically judging chart patterns will not work at all.
That is why the textbook trade of “enter when it breaks through the neckline” on double tops and double bottoms does not work.
In order to trade successfully using chart patterns, it is necessary to understand “the situation in which the pattern appears” and furthermore, to consider “how the collective psychology works.
Is that a possible turning point in the chart?
The chart pattern of double tops and double bottoms is called a “reversal pattern”.
It is literally a pattern in which the previous trend loses its sense of direction and reverses.
Earlier, I mentioned that it is important to think about group psychology in order to develop a favorable trading strategy.
So, what is the situation in which a double-top/double-bottom pattern is established and market participants are thinking that a reversal may occur?
If you have been familiar with “highs and lows” and “support and resistance lines,” you may have some idea of what I am talking about.
A situation in which everyone thinks that a reversal may occur is a situation in which a chart pattern is formed around a price area that attracts the attention of many traders.
Even if a reversal pattern forms on a 1-minute or 5-minute chart, the number of traders paying attention to it is limited. Many traders do not even look at these small time charts to begin with.
However, the number of traders who pay attention to large time charts, such as hourly, daily, and weekly charts, increases by an order of magnitude because various traders are analyzing and monitoring them on a daily basis.
This means that when a pattern is forming near a line on the upper time frame (large time frame chart), many traders will begin to think that a reversal is about to occur.
When a double-top or double-bottom reversal pattern begins to appear at a point where many traders think a reversal is possible, the possibility of a reversal increases as a result of the collective psychology.
This is such an important point that simply by keeping this point in mind, you can reduce the number of unnecessary losing trades.
It is a sign that the chart tells us
In other words, if a double top/bottom pattern appears near or around a support/resistance line on the upper time axis chart, it is a sign from the chart that a reversal may be in the offing.
This sign is created by the emotions of the market participants – the collective psychology.
If you can decipher it, you will be able to trade favorably within the pattern.
Dissecting the group psychology that arises in a double top
Now, let’s follow the group psychology and take a closer look at how the reversal pattern is formed. You will gradually come to understand the meaning of the “signs” that the patterns emit and how to “use” them.
First, look at the diagram below.
It broke out of the red resistance line drawn at the high. After that, the price has reversed after reaching a new high.
So far, we can see that the trend condition is continuing.
The collective sentiment of market participants seems to be that the market is in a trend and may make another new high.
Growing distrust of trend conditions
However, the exchange rate failed to appreciate, reversed and fell.
At this point, the collective mindset was “Huh? Is the trend weaker than expected?” and a sense of distrust begins to emerge regarding the trend condition.
Then, at the timing of the reversal without renewing the high, a support line is drawn at the previous low.
This is the “neckline”.
Further distrust after the neckline is breached
The rate then broke below the neckline (red circle).
(*Additionally, the red line that was drawn earlier was also pulled out without becoming a roll reversal).
When this happens, the collective psychology of market participants becomes very distrustful of the trend. And traders with buy positions are probably very worried.
Group psychology begins to tilt toward “reversal”
Early traders will make a sell entry at the timing of the “neckline breakout. At this point, they have already decided that the market is about to reverse.
It is true that once the neckline is broken, traders who have been holding positions in the trend will start to take profits (i.e., sell to settle their positions), and there is a good chance that the rate will temporarily fall sharply.
Therefore, entering at the timing of the breakout of the neckline cannot be denied simply because it is risky.
However, judging by the Dow Theory, it is still on the upside
At this point, we need to remind you of the definition of a trend and how to define your line of sight.
*If you are wondering what is the definition of a trend and how to define the line of sight, please read and understand the following article carefully.
>>What is the Dow Theory? Defining Trends and How to Switch Eyes
The collective sentiment is that the trend has not lost directionality until the “push low” has been broken below.
Applying the definition of a trend, the uptrend is not yet over, and the eyes are still on the upside, so we are in a situation where the buying forces may come back to life at some point.
In other words, “sell at the breakout of the neckline” is a sell trade in a situation where there is still a possibility of upward movement in the collective psychology.
This is the reason why we consider trading at the timing of the neckline breakout to be early. And it is also why trading according to chart patterns alone does not work.
What is important is the overall situation from a larger time frame perspective.
Rebounding at push lows, but mood of reversal strengthens
It was then supported by the “push low” support line (blue circle).
The “push low” is where traders who believed the uptrend was continuing would try to buy entry, thinking they could buy at a discount.
However, the rate then reversed and fell back down as the neckline became the resistance line (roll reversal occurred) at the red circle.
You can imagine that the collective psychology is quite bearish that this may not go up again.
How much can you imagine that this chart will go up in the future?
Many traders who had a buy position may start to flee and place sell orders to close out their positions.
Selling forces that had been waiting for an opportunity entered the market in earnest
When this happens, traders who have been waiting for an opportunity to sell on a reversal begin to enter the market in earnest and take up selling positions.
Why is this?
This is because the possibility of a “cutback of highs and lows” appeared when the red-circled “high” formed below the neckline.
Remember the definition of a trend here. It was “a rounding up (or down) of highs and lows.
At this point, we are seeing price action in reaction near the neckline, and it appears that some market participants have begun to judge that “there is a strong possibility that the high will be cut back.
If the price continues to fall and makes a new low, and the “high price devaluation” becomes clear, the definition of a downtrend will be fulfilled.
In other words, at the position shown in the figure, the possibility that the conditions for a downtrend will be met can be considered to have occurred, and it can be said that there is a possibility that we can ride the initial movement of the trend.
Therefore, this can be seen as one of the most effective entry points for a double top.
But again, let us consider this carefully.
In the market, anything can happen
“I see, so this is how I should make my decision and enter there!”
You may think so, but anything can happen in the market.
Please remind yourself again of the definition of a trend and how to set your eyes on it.
In this chart, the uptrend is still “continuing” and the market is “looking up” – in other words, the collective market sentiment is that there is “still upside potential”.
The Dow Theory states that “a trend continues until a clear signal occurs,” and as long as the price has not broken below the low at this point, it can be judged that the uptrend is still continuing, no matter how much the possibility of a downtrend arises.
In other words, this situation can be described as “a situation where buying and selling forces are clashing.
In this chart, we omitted the larger time horizon chart in order to keep things simple. However, what if the larger time frame was in a strong uptrend?
In that case, it is quite possible that the chart above will turn out like the one above.
Thus, if the major time frame was in an uptrend, this “reversal at the push point” would be an excellent time for a buy entry.
No matter how much the chart pattern may look like a “reversal to the downside,” if the collective sentiment is that there is a possibility of an uptrend, we should not easily trade in the direction of a reversal.
Here’s an addendum
As an additional note, I do not deny that one positive strategy in such a situation is to enter the market with the assumption that the high price will cut down, based on the understanding that the direction is against the major time axis.
Rather, I think it is a reasonable scenario to trade with a small stop loss after understanding the situation and setting a profit-taking target.
It is wrong to trade without understanding these details, thinking that you should be able to easily make a profit.
Thus, the collective psychology finally tilts toward a “market reversal”
Now, we have finally broken below the push low at the red circle.
When the price breaks below the push-low and the uptrend is negated, many traders who have been in a buy position up to this point are no longer in the mood to buy.
The collective psychological mood finally admits that a reversal is in the offing, and the likelihood of a decline in the rate increases.
In actual trading, if the stop-loss margin is acceptable, it is acceptable to enter the market aggressively at this red circle.
As a safe bet, it is recommended to enter after confirming that the rate has come back further from there and rebounded around the push-low line.
Meaning of Double Top and Double Bottom and How to Trade – Summary
So far, we have looked at the group psychology in the double top and explained how the pattern is formed.
As you can see, it is difficult to win consistently on double tops and double bottoms simply by saying, “I entered the market because it broke through the neckline.
Indeed, it may be possible to profit depending on how you fight, since the group psychology clearly starts to tilt at the point where the neckline is involved.
However, there is a point to be noted there.
That is the existence of push lows and return highs.
Tracking changes in group psychology from a larger perspective
Until the push low (return high), which is the focus of many traders, is passed, the collective psychology is seen as “still on the upside”.
Even after the neckline is breached and the mood begins to suggest that a reversal may be in the offing, there are still traders who see a breakout of the neckline as an opportunity to buy entry at a lower rate.
Therefore, it is important to have a good understanding of the position of the double top and double bottom in relation to the lines on the upper hourly chart, and then develop a trading strategy for the double top and double bottom.
It is not the “appearance” of the pattern that is noteworthy, but the “group psychology”
Most importantly, we must pay attention to how the collective psychology of the market participants changes as the pattern takes shape.
- Which line will a trader with a buy position be anxious or fearful if it breaks through?
- At which point will traders who are in a buy position feel fear and let go of their position (cut their losses)?
It is important to think about these questions.
In technical analysis, you cannot tell what is important if you are only concerned with the appearance of the pattern.
It is necessary to read the trend of the group psychology, in which everyone was riding the trend and enjoying the excitement, but then began to feel that something was wrong, that it would be bad if it continued, and then fear that it was no longer possible.
This is how to use the double-top/double-bottom reversal pattern.
This is my explanation of the meaning of double tops and double bottoms, how to trade them, and how to read the market psychology.
Related FXのチャートパターン関連用語の意味と解説まとめ
Preview of next installment
In the next article, we will discuss the head-and-shoulders (triple top-ceiling).
We will explain this reversal pattern as well as how to trade it, following the group psychology as in the case of the double top and bottom.
Please click on the link below.
■Next, please read this article.
>>What is Head and Shoulders? What it means and how to trade it
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