The double top pattern is one of the most common technical patterns used by Forex traders. It’s certainly one of my go-to methods of identifying a potential top.
Just as the name implies, this price action pattern involves the formation of two highs at a critical resistance level. The idea that the market was rejected from this level not once, but twice, is an indication that the level is likely to hold.
However, as simple as that may sound, there are a few critical things that must be present for this topping pattern to be useful (and profitable).
By the time you finish with this lesson, you will know exactly how to identify a double top as well as how to enter and exit the pattern to maximize profits.
I’m also going to share with you a simple but effective method of staying out of trouble.
Let’s get to it!
Before we can learn how to trade a double top, we first need to know how to identify it as a chart pattern.
So let’s look at the characteristics of the pattern using the illustration below.
As you can see from the diagram above, the market made an extended move higher but was quickly rejected by resistance (first top).
The market then pulled back to support and subsequently retested the same resistance level (second top). Once again the market was rejected from this level.
One common misconception is that the double top pattern becomes tradable once the second top forms.
The truth is, a double top is only confirmed and therefore tradable once the market closes below the support level (neckline).
Notice in the illustration above that the market is now trading back below the neckline. This confirms the double top pattern and signals the first part of the breakout.
Now that we understand the dynamics and characteristics of a double top let’s look at a real-life example.
Here we have a double top that formed on the EURUSD daily chart. Notice that we have a well-defined neckline support level as well as a subtle “M” shape that has been carved out as a result.
You may have come across “M” and “W” (double bottom pattern) in your internet travels.
While these are considered separate technical formations, in my experience, they are remarkably similar to double tops and bottoms. In fact, it’s often hard to tell them apart.
For this reason, I tend not to separate the two, but I do like to see a well-defined M or W from the patterns I trade.
Okay, back to our EURUSD topping structure…
Here’s a question for you – at what point was the double top below confirmed?
Care to wager a guess?
If you guessed the daily close circled above, great job!
Because we’re trading this double top pattern on the daily chart, we would need to wait for a daily close below neckline support.
So as soon as the candle above closed (the one with the red circle), we had a confirmed topping pattern.
Up to this point, we have discussed the dynamics behind the double top pattern as well as its characteristics.
You should also know how to confirm a double top breakout.
Now it’s time for the really fun part – finding out how to profit consistently from these setups.
The first thing you need to know is that the initial breakout is not what triggers the trade setup.
What we need is a retest of the neckline as new resistance. This ensures a favorable risk to reward ratio, which is an essential ingredient if you wish to succeed in this business over the long-term.
Here’s an illustration:
Notice in the illustration above how the market retests the neckline as new resistance. This is where we now have an opportunity to short the market.
Let’s revisit our EURUSD pattern to see if we can identify a favorable point of entry.
In this scenario, we would have waited for the market to break the neckline and then retest the level as new resistance.
Upon retesting the neckline, we could look for bearish price action on one of the lower time frames to help confirm that the level is likely to hold as new resistance.
Notice how the EURUSD currency pair sold off heavily immediately after retesting the neckline.
First things first, we always want to use price action to identify potential targets for any chart pattern.
It doesn’t matter if it’s a double top or a head and shoulders pattern, the best and most efficient way of finding a profit target is to use simple price action levels.
That said, there is another way to estimate the potential move of a market after the formation of a double top.
It’s called a “measured move”, and the concept is incredibly simple.
But before we move on I should point out that there are in fact two terms you need to know.
Measured move: The distance (in pips) from the broken level of the pattern to a future point in the market.
Measured objective: The level at which the market is likely to find an increase of buy or sell orders.
So to summarize, a measured move specifies the distance of something while the objective defines the exact level or target.
To find the measured objective, you take the distance from the double top resistance to the neckline and project the same distance from the neckline to a lower, future point in the market.
Here is an example from the EURUSD double top.
The distance from the double top resistance level to the neckline, in this case, is 270 pips. Therefore we would measure an additional 270 pips beyond the neckline to find a possible target.
Besides, I don’t know too many traders who will complain about booking 270 pips of profit.
Okay, so this may be a bit redundant but I have to cover it.
A double top pattern without the close below the neckline is not technically a double top.
Allow me to explain…
I hear many traders calling two tops near an important level a double top all of the time. However, unless the neckline has been broken, they are mistaken.
What they think is a reversal pattern could just be consolidation.
I made a short video to illustrate this point.
So you see, no double top is complete until the market closes below the neckline. Not only is it not complete, but attempting to enter before having a confirmed setup can get you in a lot of trouble.
Now that we’ve covered the various aspects of trading the double top, it’s time to put it all together.
The video below will walk you through the entire trading process from start to finish.
We have covered a lot in this lesson so let’s recap the most important points.
The double top is a reversal pattern which typically occurs after an extended move up. It signals that the market is unable to break through a key resistance level.
There are three parts to a double top.
A double top is only confirmed once the market closes back below neckline support. The trade setup is formed when the market retests the neckline as new resistance.
A measured move objective can be used to find a potential profit target. To find this you simply take the distance from the double top resistance level to the neckline and extend that same distance beyond the neckline to a future, lower point in the market.
To learn more about a reversal pattern that occurs at a swing low, be sure to read the lesson on the double bottom pattern.