Chart Patterns : Double Tops And Bottoms

This chart pattern is another well-known pattern that signals a trend reversal - it is considered to be one of the most reliable and is commonly used. These patterns are formed after a sustained trend and signal to chartists that the trend is about to reverse. The pattern is created when a price movement tests support or resistance levels twice and is unable to break through. This pattern is often used to signal intermediate and long-term trend reversals. In the case of the double top pattern in the above figure, the price movement has twice tried to move above a certain price level. After two unsuccessful attempts at pushing the price higher, the trend reverses and the price heads lower. In the case of a double bottom (shown on the right), the price movement has tried to go lower twice, but has found support each time. After the second bounce off of the support, the security enters a new trend and heads upward.

Double Top

A double top occurs when prices form two distinct peaks on a chart. A double top is only complete, however, when prices decline below the lowest low - the "valley floor" - of the pattern.
The double top is a reversal pattern of an upward trend in a stock's price. The double top marks an uptrend in the process of becoming a downtrend.

A double top consists of two well-defined, sharp peaks at approximately the same price level. A double top occurs when prices are in an uptrend. Prices rise to a resistance level, retreat, return to the resistance level again before declining. The two tops should be distinct and sharp. The pattern is complete when prices decline below the lowest low in the formation. The lowest low is called the confirmation point.Sometimes called an "M" formation because of the pattern it creates on the chart, the double top is one of the most frequently seen and common of the patterns. Because they seem to be so easy to identify, the double top should be approached with caution by the investor.

According to Schabacker, the double top is a "much misunderstood formation." Many investors assume that, because the double top is such a common pattern, it is consistently reliable. This is not the case. Schabacker estimates that probably not more than a third of them signal reversal and that most patterns which an investor might call a double top are not in fact that formation.2 Bulkowski estimates the double top has a failure rate of 65%. If an investor waits for the breakout, however, the failure rate declines to 17%. The double top is a pattern, therefore, that requires close study for correct identification.

Double Bottom

A double bottom occurs when prices form two distinct lows on a chart. A double bottom is only complete, however, when prices rise above the high end of the point that formed the second low. The double bottom is a reversal pattern of a downward trend in a stock's price. The double bottom marks a downtrend in the process of becoming an uptrend.

A double bottom consists of two well-defined lows at approximately the same price level. Prices fall to a support level, rally and pull back up, then fall to the support level again before increasing. The pattern is complete when prices rally above the highest peak in the formation. The highest peak is called the confirmation point. Sometimes called an "W" formation because of the pattern it creates on the chart, the double top is one of the most frequently seen and common of the patterns. Because they seem to be so easy to identify, the double bottom should be approached with caution by the investor.

According to Schabacker, the double bottom is a "much misunderstood formation." Many investors assume that, because the double bottom is such a common pattern, it is consistently reliable. This is not the case. Bulkowski estimates the double bottom has a failure rate of 64%, which he terms surprisingly high. If an investor waits for a valid breakout, however, the failure rate declines to 3%. The double bottom is a pattern, therefore, that requires close study for correct identification.