The Double Top Reversal Pattern

The double top pattern is a bearish reversal pattern that can be observed at the top of an uptrend and signals an impending reversal. Unlike the double bottom formation that looks like the letter “W”, the double top chart pattern resembles the letter “M”, due to the two equal highs. 

In this blog post, we will describe how to correctly draw the double top, what its structure tells us, and how to make profit trading the double top pattern by sharing a simple trading strategy.

What the Double Top Pattern Tells Us

The double top chart pattern is a bearish reversal pattern. As such, it can only occur in an uptrend as the buyers are successful in pushing the price action higher by creating a series of the higher highs and higher lows. 

Their inability to extend this bullish series initiates the creation of the double top pattern as the second peak is not registered as a higher high, but rather as an equal high. This weakness is then used by the sellers to push the price action lower and erase previous gains. 

 

 

In essence, there are three key elements of the double top chart pattern:

• Uptrend - The price action must trade in an uptrend for the double top to make sense. Remember, this is a reversal pattern. 
• Two equal highs - Getting two exact same highs is hard to imagine. As long as we can see that the horizontal resistance that capped the earlier move higher stops the buyers once again, we register this as two equal highs.
• Neckline - The lowest point of a pullback following the first peak is called the “neckline”. A simple horizontal trend line is drawn through the lowest point of the pullback. 

 

The double top formation is active once the price action breaks below the neckline. The market moves from creating the higher highs and higher lows to the lower lows, as the break of the neckline brings us lower prices compared to the lowest point of the initial pullback (the neckline). 

Ideally, a certain period of time should pass in between the two tops. In case the second peak occurs almost immediately after the first peak, with a minor pullback, there is a strong likelihood that the buyers will break above the first peak. In this case, the double top becomes a continuation pattern. 

 

For this reason, the most effective double top patterns are those with a certain amount of time in between two lows. It is also absolutely crucial to wait for a break of the neckline before entering a market, to avoid situations where the double top formation becomes the continuation pattern.

Strengths and Weaknesses

Similar to the double bottom formation, a double top pattern is one of the strongest reversal patterns out there. One of its greatest strengths is its efficiency and high likelihood of being successful in predicting a change in the trend direction. 

The neckline existence equips the pattern with a clearly defined level to play against. The neckline marks the risk and it helps determine the take profit once the pattern is activated. 

On the other hand, the biggest weakness of the double top pattern is that you are countering what is, to that point, a very powerful trend. For this reason, there is always a chance that this scenario could eventually result in a continuation of the bullish trend. Therefore, a trader should always consult other technical indicators before entering the market.

Spotting the double top pattern

The double top patterns are not so common in trading. However, once correctly identified, they become a powerful tool in the hands of a trader. A USD/CHF daily chart below gives us a great example of how to successfully counter the strong bullish trend. 

An initial bullish move results in enormous gains of more than 500 pips for the buyers. The price action moves higher in an almost vertical manner, without any meaningful pullback. Following the first peak, the price action rotates lower in the first more significant pullback.

 

 

The buyers are then able to regroup and organize another assault at the same horizontal resistance level around the $1.0050 handle. However, they fail again at the same resistance, which prompts a deeper pullback.

Trading the Double Top Pattern

The basic principles for trading the double top pattern are the same as for the double bottom pattern. Once again, the pattern is only activated once there is a clean break and a close below the neckline, preferably on a daily basis. This way, you protect yourself against the failed breakdowns, when the price action briefly trades below the neck line without actually breaking it. 

Once the USD/CHF sellers bring the price action to the point where the previous pullback lower ended, their goal now is to create a lower low and initiate a new bearish trend. They become successful in their mission as there is a break of the neckline very quickly. 

 

 

Similar to the head and shoulders reversal pattern, the double top offers two types of entry. First is a more aggressive entry, as you enter the market as soon as the candle closes below the neckline. 

The second route is based on a more conservative approach as traders wait for the price action to return higher to retest the broken neckline - a throwback - before entering the market at a higher (better price). 

This approach offers a better risk-reward ratio, but the chance of you missing out on a trade is also higher as the move higher may never happen. On the other hand, the first option offers you a mandatory ride in a trend, however, the entry may be quite lower.

 

In this case, USD/CHF never offered us a second choice as the price action flushed lower. There was a minor rebound higher, but it never reached the broken neckline. In this case, our entry is at $0.9760, a level where the USD/CHF closed below the neckline for the first time. 

The stop-loss should be placed above the neckline, allowing some space for a potential failed breakout, if the price action rebounds to retest the neckline. Thus, we put a stop-loss at $0.9820, around 30 pips above the broken neckline. Please remember that any move and close above the neckline invalidates the activated double top pattern.

 

The take profit is calculated in the same manner as it is the case with the double bottom pattern i.e. measuring the distance between the resistance (double top) and the neckline. The same trend line is then copy-pasted from the point where the breakout occurred, with an end point of the trend line being our take profit. In our case, the trend line ends around $0.9530.

The USD/CHF pulls back all the way to $0.9540, around 10 pips from our take profit. As with a stop loss, it is always advised to leave some room for the take profit, as some traders may exit their trades earlier. Ultimately, this trade banked us 220 pips while we risked only 30 pips.