Trading 101: How to Trade Double Top and Double Bottom Chart Patterns?

2021/08/03 02:05:52

Identifying trend reversals and accurate support and resistance levels is one of the simplest and most reliable trading strategies, especially for beginner traders. This can be achieved using double tops and double bottoms chart patterns.

Ideally, when the double tops and double bottoms appear on price action, it implies an impending trend reversal. The double tops often lead into a bearish trend from a bullish one, while a double bottom precedes the reversal of a bearish trend into a bullish one. Let's break them down.

Double Top Chart Pattern

The double-top is a chart pattern that indicates an imminent reversal of a bullish trend. This means that the asset must be in a sustained bullish trend before forming the double tops.

The defining feature of the double top reversal is the two highs with a moderate low in between. The second is followed by a sharp downtrend that reverses all the gains that led to the price spikes and suggests a further sharp decline. The first and the second top attained by the price represent the resistance level reached by the asset during a bullish trend.

This chart pattern signals a moderate to long-term transition from bullish due to declining market sentiment in the crypto market.

How to Identify a Double Top Reversal?

A true double top reversal pattern has six main features.

Prior bullish trend: A significant positive trend must precede a double top reversal pattern. If there is no long-term bullish trend, its accuracy declines.
First top: The first top in this chart pattern should be the peak from the observed bullish trend. This peak typically represents the profit-taking activities of traders who were in long positions. Since this involves selling their holdings, there will be a short decline in the asset's price.
The price drops: After the first peak, the prices begin to drop. This often leads to up to a 20% drop in the prices as the volume being sold increases. The low attained here will mark the support level.
Second top: The short-term sellers are counteracted by short-term buyers who push the prices up. You should note that the volume being bought here doesn't increase significantly. This period is often marked by an increase in the prices but constant or dropping volumes, indicating a divergence.

Regardless, the price will reach the high level of the high registered by the price in the first top, but doesn't breach it. Typically, the asset doesn't breach this price, marking a clear resistance level. Note that the first and the second top do not need to align perfectly in most cases, but they should always be within a 5% range of each other.

Price decline from the second top: The price will steadily drop from the second top, with the volume being sold also increasing steadily. The increase in volume continues to push the price downwards due to the strong selling pressure.

2. Breaching the support: The steady decline in prices from the second top goes beyond the support level formed in step 3 above. Breaching this level is usually the signal to short the market since the bearish trend has taken hold.

Formation of Double Top Chart Pattern on the Ethereum Price Chart | Source: ETH/USDT

Note that a double top reversal isn't fully confirmed until the sharp reversal from the second peak occurs, meaning that most traders are looking to trade when the price breaks through the support level formed by the first pullback.

Double Bottom Chart Pattern

The double bottom chart pattern is the opposite of the double top pattern. This means that when this pattern forms on the price charts, we can expect that the price action will reverse from a bearish trend into a bullish one. In a double bottom, the first swing low marks the extreme low of a long-term downtrend. As soon as the second swing low fails to go beyond the first low, we can take it as a confirmation that the bearish momentum is ending and reversing into an uptrend.

How to Identify a Double Bottom Reversal?

Identifying this reversal is the exact opposite of the double top reversal we've discussed above.

Prior bearish trend: A double bottom reversal pattern after a sustained downtrend

2. First bottom: The first bottom in this pattern should be a swing low from the observed bearish trend. This low typically represents the profit-taking activities of traders who had short positions. Remember that liquidating short positions involve buying the asset in the market.

3. A short-lived rise in the price: After the first swing low, the prices begin to rise. This often leads to a 20% rise in the price as the volume being bought increases. Consequently, the prices increase in the short term forming a resistance level.

4. The second bottom forms: The short-term buying activity in the market is counteracted by sellers who push the prices down. You should note that the volume being sold here doesn't increase significantly. This period is often marked by a drop in the prices with constant or dropping volumes, indicating a divergence.

Regardless, the price will reach the levels of the low registered by the price in the first bottom but doesn't go below it. Typically, the asset doesn't breach this price, marking a clear support level.

5. Increase in the price: The price will steadily increase from the second bottom, with the volume being bought also increasing steadily. The increase in volume continues to push the price upwards.

6. Breaching the resistance: The steady increase in prices from the second bottom will trend past the resistance level formed in step 3 above. Breaching this level is usually the signal to go long.

Formation of Double Bottom Pattern on the Dogecoin Price Chart | Source: DOGE/USDT

Note that a double bottom reversal isn't fully confirmed until the sharp reversal from the second bottom occurs. That's because most traders are looking to trade when the price breaches the resistance level.

Conclusion

A double bottom has two swing lows in about the same price range. The swing high between these two swing lows is then a resistance line. This pattern looks like the letter 'W.' Similarly, a double top, on the other hand, has two swing highs in about the same price range. The swing low between these two swing highs is then a support line. It looks like the letter 'M.'

Identify and trade these two reversal patterns on a demo account until you master it, and do not forget to use reliable indicators to confirm the signals generated by these patterns. Also, consider following the KuCoin blog for more interesting educational content. All the best!

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