Trading Strategy

How to Use Double Top and Double Bottom Patterns to Increase Profitability

June 21, 2022 | 2:57 pm | The 5%ers' Blog > Trading Strategy
June 21, 2022 | 2:57 pm
The 5%ers' Blog > Trading Strategy
How to Use Double Top and Double Bottom Patterns to Increase Profitability

Double Top and Double Bottom Patterns

For decades, traders have forecasted future price movements using the technical analysis method, which is based on the analysis of chart patterns, bar patterns, and candlestick patterns. Before receiving a signal pattern technical analysis, the price moves through steps to complete the final formation. Whatever direction the market takes next, it will be bullish or bearish.

The double-top formation and double-bottom formation are both technical analysis tools. This article responds to the following questions: What do the double-top and double-bottom patterns mean? What is the most efficient way to trade them? And what are the advantages and disadvantages of each?

 

What is the Double Top Pattern?

A double top pattern is a bearish formation that arises when strong resistance inhibits the continuation of a bullish trend on two consecutive occasions. Two peaks above a support level define the “double top” formation, generally referred to as the neckline.

After a strong advance, the initial peak occurs, and the price retraces back to the neckline. After retracing its steps back to the neckline, the price becomes bullish and advances toward the resistance level, forming the second top. The formation is complete when prices return to the neckline following the creation of the second top. Confirmation of a trend reversal occurs after breaking the “neckline” support level.

The chart has been taken from AUD/USD on Dec-9–2021 based on a four-hour time frame.

 

Double Top Pattern on AUD/USD 4h.

The graph above illustrates market phases and where traders should set stop-loss orders.

Sellers wait for a bearish trend to be confirmed before they place sell positions, by a breakthrough in the neckline confirms the bearish trend.

 

Double Bottom Pattern

A double bottom pattern is a bullish formation that occurs when strong support prevents the continuation of a bearish trend on two consecutive occasions. The “double bottom” pattern is formed by two bottoms under a resistance level, also known as the neckline.

The initial bottom comes following a strong drop, and the price then retraces back to the neckline. Following a return to the neckline, the price turns bearish and falls to the support level to form the second bottom. The formation is complete when prices return to the neckline, forming the second bottom. Finally, the bullish trend reversal is confirmed when prices breach the neckline or resistance level.

Double Bottom Pattern Example

 

 

The Pros and Cons of Trading The Patterns

Let’s see what the pros and cons of this trading method are

The Pros of Trading Double-Top and Double-Bottom Patterns

One of the advantages of using the double top and double bottom patterns is that traders can find them in all time frames. Therefore it can be used by various traders.

Traders who dislike holding positions for extended periods seek out shorter time frames, such as 15-minute or 5-minute time frames, or even one-minute time frames, while traders who prefer to hold positions for extended periods seek out one-hour or four-hour time frames, such as long periods of one day, one week, or even one month.

Another advantage is that traders can spot double top and double bottom patterns on a variety of currencies, commodities, and stock market charts.

Since the market repeats itself over time, the double-top and double-bottom patterns have been tested and traded throughout the years.

The Cons of Trading Double-Top and Double-Bottom Patterns

A fake breakout is one of the things that makes traders fall in anger.

In the graph below, the price has broken through the neckline, or support level, before reclaiming the top. That’s where traders should set their stop loss. This fake breakout could also be seen in double bottom patterns.

Fake breakout

The double-top and double-bottom patterns have the same pips between the profit target and the stop-loss point. Therefore, if you calculate the number of pips between the two destinations in the graph above, you will get the same result, which implies that traders take a risk equivalent to the possibility of profiting. Therefore, this pattern cannot be used to support tactics by traders seeking reward-to-risk ratios greater than one-to-one.

Professional traders also encourage traders to choose a reward-to-risk ratio greater than one-to-one. However, traders should stick to a risk-to-reward ratio of 1:1 while using this technical analysis tool, as seen in the graph below.

Same pips between the profit target and the stop-loss point.

 

Momentum Indicator to Determine Entry Level Points

What is the most useful momentum indicator? and how to apply it to determine the entry-level and the possibility of continuation potential for the price?

The Relative Strength Index is one of the most popular trend indicators that has been used for decades to measure market strength. The RSI indicates the probable price increase or decrease. When the value-line for the RSI is over 70, it means that the price is in an “overbought” zone, which suggests a likely end to the uptrend. When the value line of the RSI is below 30, on the other hand, it means that the price is in an “oversold” zone, which means that it could go even lower.

The Relative Strength Index may hit 90 on the value line before it makes a reversal. On the flip side, the RSI could hit 10 in the value line before it makes a reversal. As previously stated, 70 indicates strength and high demand for an asset or currency. In contrast, a reading below 30 indicates a decline in demand and an increase in sales.

The following illustration demonstrates how the Relative Strength Index (RSI) aids in determining entry into a sell position.

As we see, the RSI was below 70 when the price reached its first and second peaks, followed by price reversals. In addition, the RSI was below 30 on the value line when the price broke the neckline, supporting the downside potential continuation and indicating a selling opportunity.

RSI helps in determining entry into a sell position

The Relative Strength Index can be utilized in two ways, the first of which is illustrated in this piece.

Alternatively, some traders place a buy position when the RSI is in the oversold zone (below 30) and a sell position when the RSI is in the overbought zone (above 70).

Before engaging in trading, your task is to analyze historical data to determine which strategy is most successful and will work for you the most.

 

Double Top and Double Bottom Summary

Over the years, the market has formed double top patterns and continues to repeat itself. So, you must first create a statistical model for double top formations, confirm that it is profitable for you before entering the market, and place a sell or buy order in the time frame you want to work on. Then, as a result, it may be included in your trading strategy.

 

This article was written by Mohammad Quqas from mohammadquqas.carrd.co

 

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