The beautiful thing about chart patterns is that they often leave little room for interpretation.
Take the dual patterns of the double top and double bottom patterns. In both cases, they describe rather perfectly what investors see at first glance. A double top will produce two distinct peaks within a given chart parameter, while a double bottom will produce two separate troughs within a given parameter. These chart patterns have a lot more to say about the performance of a given stock that goes beyond these well-defined points.
What the Look of the Two Patterns Tell Us
Double-tops and double-bottoms may be the easiest patterns to spot on a chart. A double top’s pattern will typically look like an “M,” while a double bottom’s pattern will typically look like a “W.” No matter how the peaks form, they are both representative of reversal patterns that demonstrate a stock’s attempt to continue on their existing trend. However, upon several attempts to continue on their current course of the movement, the trend reverses, and a new trend begins.
The peaks, of course, provide us important insight that investors can use to extrapolate important data. In the case of a double-top pattern, the pattern’s peaks are formed at the height on an upward trend, sending a clear signal that the preceding upward trend is beginning to weaken and that buyers are growing tiresome of the stock. When the pattern is finished, the trend is considered to be reversed, and the stock is poised to drop lower.
The Stages of a Double Top or Double Bottom Pattern
The best way to view a double top or a double bottom pattern is to take a look at the various stages that form the pattern in the first place. This provides savvy investors with a deeper level of insight that they can use to make the most informed decisions possible regarding the patterns’ mined data.
The pattern’s first stage is marked by the formation of a new high during the upward trend. When this trend peaks, it will face resistance and sell off to a level of support. When this occurs according to the pattern, the stock price will start to move back toward the level of resistance located in the prior run-up before once again selling off back to the support level. The pattern is finished when the stock price either falls below or breaks down the support level that had previously cushioned the previous declines made by the stock. When this happens, a downward trend ensues.
It should be noted that in the case of a double top pattern, the stock line need not necessarily touch the level of resistance. However, it should be close to the prior peak. Additionally, investors should wait for the price to break before the critical support level before entering a stock. It’s important to bear in mind that the pattern is merely setting up the possibility for the trend reversal to occur, and that trading within the sectioned range could continue for an extended period. Investors that jump the gun and try to trade before the signal is formed could be met with some pretty awful results.
Ultimately, the pattern that a double top pattern creates is a crystallized illustration of the battle that exists between buyers and sellers. You have the buyers that are attempting to push the stock but are facing the kind of resistance that puts the continued upswing of a trend to a halt. However, after a couple of noble attempts, the buyers begin to admit defeat, and the sellers start to take over the stock, sending the stock into a new downtrend in the process.
When you flip these metrics over, the investor will see that the precise metrics exist in a double bottom situation. In this case, the sellers become the ones that end up admitting defeat, and the buyers are the ones that end up forcing the issue.
Regardless of where the peaks form, it’s important to remember that volume plays a huge role in determining the legitimacy of a chart pattern. If volume is not visible in support of what appears to be a trend in either direction, it’s probably not as strong as a trend as the chart may otherwise indicate.
The Importance of Price Objectives and Pattern Adjustments
Seeing peaks on a chart doesn’t come close to presenting the full story. From a technical analysis standpoint, it’s imperative to view other associative actions on the chart to get a full story. This doesn’t call for technical analysts to abandon their philosophies and dive into the type of minutiae that fundamental analytics demands. However, it does require the investor to scrutinize the elements that lead up to the all-important stock price.
This isn’t necessarily a snap to do. Unlike what we tend to see when we look at the double top and double bottom patterns, charts can be messy and imperfect. Metrics that are crucial to determining the overall trend behind the pattern, such as price distance between support and resistance levels or testing points, can be difficult to decipher. If investors aren’t careful, one misread component associated with a pattern can lead to some pretty disastrous financial decisions.
However, indicators like volume can produce signals large enough to minimize the chances of misinterpreting the real story a double top or a double bottom pattern may be trying to tell. Using these metrics to unearth a complete picture are not difficult to utilize, either. To be sure, they are a whole lot easier to deal with than a market fund that is swiftly depleted by a couple of mal-informed maneuvers.
The bottom line here is that double top and double bottom patterns can be used as high reversal patterns, and savvy investors can use these patterns to pursue substantial trading opportunities. At the same time, it’s important that investors use these patterns with the same measure of caution reserved for every other aspect of technical analytics. Just because something looks easy does not translate into easy money.