Double top and double bottom pattern is one of the most known patterns from price action strategies along with head and shoulders pattern. Double top (also called M pattern) and double bottom pattern (also called W pattern) are reversal patterns and both are very effective. Double top and double bottom pattern is formed from two peaks or two bases, which have the heights, respectively the lows at approximately the same level.
The Double Top And Double Bottom Pattern Structure
After a strong thrust (momentum / impulse), the price finds it’s resistance (for an uptrend) / support (for a down trend) and it can’t break thru it. There is a market trend in the opposite direction which usually is a bigger correction. This is the first sign of trend change. The price impulse continues to a certain level, after which there is a large number of buyers (for an uptrend) / sellers (for a down trend) in the market who are trying to continue the initial trend. Their test fails when the price rises close to the level of the previous height (for an uptrend) / low (for a down trend). This leads to closing the buying (for an uptrend) / short (for a down trend) positions and simultaneously increasing the short (for an uptrend) / buying (for a down trend) positions. A new thrust (momentum) begins, which penetrates the previous low (for an uptrend) / height (for a down trend). Through this breakthrough the figure is confirmed.
Here is a Double Top pattern (aslo called M pattern) formed on GOLD chart on H1 (one hour) timeframe:
Characteristic of Double Top And Double Bottom Pattern
- The difference between the heights for an uptrend) / lows (for a down trend) of the two peaks (two bases) should not be very high (at most 20%);
- The second peak must always be equal or lower than the first. A similar situation is also true for the second base: it must reach at least the previous minimum level. If this condition is not met, then new heoghts / lows appear, representing the continuation of the original trend trend;
- There is an exception to the previous rule and in that case we have a Double Bottom / Double Top with fake breakout. Fortunately there is a good free indicator for this situation and you can find it here;
- The figure appears at the end of a strong price movement;
- Stripping the figure support line (for an uptrend) / resistance (for a down trend) is a signal to open the position;
- The target for profit is the projection of the distance between the highest / lowest point of the pattern, drawn from the breaking point in the direction of the penetration;
- The Stop Loss order is placed above / below the height / low of the last peak / base;
- After the penetration it is possible for the price to return to penetration’s level (retest), after which the market continues the evolution towards the target set by the figure;
How to trade the Double Top And Double Bottom pattern using AB=CD Pattern
Let’s take a closer look at the Double Top pattern formed on GOLD from our earlier example:
The biggest advantage of this way of trading is that instead we open our position at the breaking of support / resistance line, we are already into a position which means that we made some profits and we are in a “free ride” position.
After we opened our trade we need to place a Fibonacci Retracement on the AD swing so we can follow it’s levels in order to secure profits.
Now, because we are already into a position and we already made some profits, we can add another position to our opened trade at the breaking of the support / resistance line keeping the same stop loss from our initial opened trade.
We secure profits in the same way I explained into the AB=CD pattern article at all Fibonacci Retracement levels. Also, we move our stop loss to the previous Fibonacci Retracement level as the price reaches the next levels (for example, after the price reaches 50.0 Fibonacci Retracement level we move our SL few pips above 38.2 level, and so on).
Don’t forget to use a proper risk and money management and check for every trade opportunity the SL size and if there is an acceptable loss. If there is an unacceptable loss the trader will simply skip the trade and move to the next one. It is recommended to use a risk of maximum 2% to 5% of equity.