Double Top or Bottom

The double top and bottom is a popular reversal pattern. This shows that a stock is going to head up or down but will not go too far beyond the peaks that are listed. After reaching those peaks, the stock will go in the opposite direction of where it had been moving.

How the Double Top Is Formed

The double top features a stock that trends upward at the start:

1. As the stock moves up in value, it will eventually reach the first top. This is the highest value that the stock will reach.
2. The stock will then pull back down in value. There are no standards as to how much of a difference should be found between the pullback value and the first top.
3. The stock then rallies back up and reaches the second top, which should be about as high as the first one.
4. The stock then moves down to the original pullback low.
5. There might be a chance that the stock starts to move up in value or stay the same, but eventually, the stock will break below that pull back total, thus finishing the double top.

The double top can give you an idea of when you might want to trade a stock as it is within the pattern. This pattern works especially well if you want to place a put option on the stock. Look at how the second top is formed at this point. This is the point where you can enter into a short sale or a put option.

How the Double Bottom is Formed

The double bottom is formed in the same fashion as the double top but in the opposite direction:

• The double bottom starts when the stock is experiencing a downward trend.
• The stock will appear to get to its lowest total twice.
• After a while, the stock will move beyond its pullback value and start to go up in value.

The double bottom is ideal for call options. You will notice when you review the trend how the stock is about to rise in value.

Selecting a Price Target

No matter whether you trade the double bottom or top, you can set a price target for whatever you want to invest in. Here is how to set up a price target:

1. See where the double top or bottom is formed. For instance, you might see that the double tops on a stock are at $45 and $44.
2. Use the midway point between the two peaks. For this, you will use $44.50 as one border.
3. Look at where the opposite ends of the trend are located. Get the midway point between those two. In the example, the bottom parts that appear after the double tops are at about $35 and $33. Therefore, the midway would be $34.
4. Find the difference between those two totals you have gathered. Subtract $34 from $44.50 to arrive at a difference of $10.50.
5. Add or subtract the total to or from the breakout point. Since the double tops show that the stock will go down in value, you must subtract $10.50 from the breakout. The second bottom part was at $33, so let’s use that as the breakout mark. The price target you should use would then be $22.50.

In short, you would place a put option on the price going below $22.50. You could also use this as a means to see if the stock will rally at the $22.50 mark if it gets there. Either way, you have a benchmark to work with to identify how the stock will change in value.

Where to Create a Stop-Loss

You have two options to work with when getting a stop-loss planned on your double bottom or top stock trade:

1. Create a stop-loss at the midway point between the breakout point and the tops or bottoms. For the double top example listed above, you would use a stop-loss total of approximately $38.50. This is in between the $44 top and the $33 breakout mark.
2. You can also choose a stop-loss around the double top or bottom spot. A stop-loss of $44 could be used to stop you from losing anything in the event that the stock goes beyond that original peak.

You have the option to keep the stop-loss at other values for the stock if you wish. These two options are recommended as they present less risk.

Space Between Each Top or Bottom

Look at the number of candlesticks in a double top or bottom pattern to see how it is developing. A good trading pattern should have about four to seven sticks in between the bottom or top and the opposite end. This indicates how the stock is trying to get past a certain total but is struggling to do it. This also shows that traders have some sense of control because the top and bottom swings are consistent. You might feel more confident in a trade if you notice that the spacing between the top and bottom parts is consistent.

Can a Triple Top or Bottom Occur?

There is a chance that a double top or bottom might have three peaks or valleys instead of two. This is not always going to be the case, but it is a possibility when you consider how the double top or bottom might indicate a sense of uncertainty among investors.

In a triple top or bottom, the third peak or valley will be slightly off from the first two. On a triple top, the first two tops might be $50 and $52 while the third top is $46. This is a noticeable shift from the others and adds some confirmation that the stock is going to head in the opposite direction from where it had been moving the first time around. Triple tops or bottoms are not always going to occur. If this does happen, the third instance is not going to be very intense.