A Beginners’ Guide to Trading with Double Tops and Double Bottoms
If you are planning to try your luck into forex trading, like any other trader, you will have to look into the concept of trading with ‘double top’ and ‘double bottom.’ While they come across as a part of the jargon associated with forex trading, they certainly are not.
When you study the graphs that represent the price trends of a currency, you will come across various patterns that are potential predictors of future trends. Two such trends are double tops and double bottoms. Essentially, the double top is visible when you can see an’M’ in the chart, and the double bottom is when a ‘W’ is visible in the same.
Here, we are going to take through what both the terms represent and how traders use these patterns to make a living.
- Double Top
Over a long period, you will be able to detect two consecutive rounded tops, not necessarily peaked at the same level, on the line graph of your currency of interest. The first one of the two rounded tops, definitely, will create an inverse U. And, as you should know, rounded tops can predict bearish reversal because they are visible after a stretched bullish rally.
Similarly, if there are two rounded tops, they will indicate a bearish reversal. In the case of a double top, the second rounded top will indicate resistance and exhaustion and will always be slightly, or more, below the first one.
Since you are just beginning to learn the study of market trends, you should know that it is not often that you will come across double tops because they are rare occurrences that tell you that investors are looking to obtain final profits by selling off their investments. It is the bearish reversal that is anticipated to follow, compelling traders to sell off their stock.
Why the Bearish Reversal Trend?
The reason behind the fact that traders assume a bearish reversal after the double top is because – if you notice the pattern, the first top is the highest point the currency ever reached. After the price went down a little, it bounced back within a short duration, which should be good. However, the new top was not able to break the record-high price of the first one. – This indicates that the buying pattern is about to finish.
Decreased buying pressure after a double top can be so severe that the price falls past the neckline and doesn’t seem to stop. An uptrend as attractive as the double top is not something you should get attracted by because since the buyers are exhausted, you are better off taking out the final profits. If you do not sell at this time, you will have to take a more emotional exit.
- Double Bottom
In its essence, the double bottom is the opposite of the double bottom. When you study the currency of your interest over a while, you will come across a pattern which forms a ‘W.’ Since W is the inverse of M, it is only fair that the inferences from the double bottom are reverse of inferences from the double top.
Two rounded bottoms create a double bottom. It is often the end of an extended bearish pattern that brings these rounded bottoms into the light. However, the pattern begins appearing with a single rounded bottom that is a sign of reversal. However, when a consecutive rounded bottom joins it, it indicates that investors are following a more secure pattern to capitalise on the last lower push.
The two bottoms show how investors are taking advantage of the falling prices of the currency. It is a bullish reversal trend that should not be ignored, as many investors have gained immensely by identifying it. Traders leave no stone unturned to make profits from this bullish rally. It is often observed that the trading pricing after a double bottom will rise tremendously.
Why the Bullish Reversal?
When studying the markets in patterns, it is crucial to notice the extreme lows and highs of a currency. The reason why double bottoms lead to a rise in price is – the first rounded bottom is the lowest the currency has hit over the year. Even though it rises for a short time, it doesn’t take long to fall. However, the fall could not go past the first bottom. This indicates that the sellers have exhausted their stocks. Now that the seller pressure is almost finished, the prices will definitely rise.
Also, the price rise in the currency is similar to the fall. So, when a market is showing a strong downtrend, there is a possibility that double bottom will occur to revive the market.
Limitations of Double Tops and Double Bottoms
Jumping to conclusions is one thing that beginners should refrain from. So, even if you spot similar patterns in the market as a double up and double bottom, make a closer observation. This is because, if interpreted correctly, they can prove extremely beneficial for your trade. However, if your interpretation fails, you will lose a significant amount of time and money.
It is the sharp jumps followed by sharper declines that represent a double top. Therefore, you should only look for an extremely bearish pattern in the market. If you end up reading two consecutive peaks incorrectly, you can lose out on the position that you already hold in the currency market.
Where to Find Double Tops and Double Bottoms?
Often, traders are unable to figure out the patterns because they are looking at the wrong part of the graph. So, if you want to be accurate with your predictions, look for double tops at price highs and double bottoms at price lows. Also, since they are reversal patterns, why not focus on the M forming near bearish trends and W forming near bullish trends?
How to manage Risks during Double top and double Bottom?
Placing stop loss is one-way traders can prevent their investments in forex to cause losses. It is a level of price fall at which they order their brokers to sell off the assets.
When it comes to pattern trading, traders prefer that the trading should be stopped when the asset is above the lower top. However, this leaves your win or loss ratio below 1:1. This is because the chances that this pattern will appear are only 60-70%, you will lose out on potential profits and market position earlier.
Therefore, the trade will be more favourable if you allow the stop loss to remain close to the entry-price. This will make the chances of your win higher by 70%.
In the case of Double Bottom, you should make sure that you don’t end up exiting the market just because of the bullish trend. So, place your stop loss strategically. Moreover, if you are keeping a close eye on the market trends anyway and want to make a living out of it, you should not opt for setting stop losses.
In the end, whether it is in the forex market or regular investment market, double top and double bottom can prove a great help for traders. However, as a trader, you need to be careful when studying these trends. Keep the main characteristics and results in mind, to begin with. Once you have identified the trend, you can deal in any currency of your interest.
