Okay, now it is time to start looking at some patterns that we can see on our charts. Double top and double bottom patterns appear on our charts when the price action of the currency pair moves in a similar way to the letter “W” or “M”.
The letter “W” represents a double bottom as it shows the price rebounding off of the same price point twice. This indicates a bullish trend reversal.
The letter “M” represents a double top as it shows the price rebounding off of the same price point twice. This indicates a bearish trend reversal.
These are very important technical analysis patterns that we can use as traders to try and predict where the price will move in the future.
Here is a diagram of a double top. As you can see, the market is in a bullish/uptrend and moves on to create a new high (shown as peak 1 in the diagram). The price then falls down before bouncing back up again to create another high (shown as peak 2).
When the price falls after reaching peak 1, the area that it reaches is referred to as the “neckline”. This is a vital price point that we will come to in just a moment.
For this to qualify as a double top, peak 2 must not exceed the heights of peak1. The bullish trend must try to break new heights but fail and then fall back down to the necklines.
So how do we trade based on this information? During a double top, we would enter a sell/short position when we see the price break the neckline after the second top. The breaking of the neckline confirms the double top and usually signals a bearish trend reversal that we can capitalise on.
As you can see from this example, we have two clear peaks and then a clear break through the neckline following the second peak. This would be our entry point for a sell.
No points for guessing what a double bottom is. Yep, it’s the mirror image of a double top.
Here is an example of a double bottom. As you can see, we had the first bottom followed by a rebound up to the neckline followed by another rebound to the second bottom.
We should enter a long position when we see that the neckline has been successfully broken.
Tip: Double tops and double bottoms can be extremely profitable if we can successfully identify them. However, if you misidentify one then it can be very costly.
Make sure you set a tight stop loss and manage your positions carefully. It may be beneficial to paper trade these patterns for a while before live trading them so that you can practice spotting them without putting your trading capital at risk.