Tuesday, December 1, 2009

Trading Double Tops And Double Bottoms

by rsbombard

Traders need to look out for indicators that make patterns that trigger long or short positions by following the trend reversal signals they give. Patterns like doubletops and double bottoms are significantly important for a forex trader as it is for an equity trader.

What Are Double Tops and Double Bottoms

Double tops signal out a long drawn bearish trend. Double tops form usually close to the 52 week high with an intervening trough. Both the tops are roughly equal in price with the first having formed after long advance trending of currency pairs. Patient observation is critical here to pick the accuratetops without getting misled by fake tops. The declining trend after the second top finds a support near the intervening trough level which if broken is the signal for entering short positions or closing long. The target is equal to the difference to the difference between thetops and the intervening bottom. When perfectly formed, the double tops appear like the letter ‘M’.

There are two things of importance when judging the double tops.

1. The first top should have formed after sufficiently long advance trending and the gap in between the tops must take at least a few weeks to a couple of months.

2. The second top must be within 3% of the first and breaking the support line is marked with high volumes under selling pressure.

Double bottoms are different from double tops in only one way that the pattern is exactly reverse of double tops. When accurately formed, the double bottoms formation appears like the letter ‘W’. The trend following the second bottom is associated with increased buying pressure as reflected by the volumes chart. Volume further picks up once the resistance is broken effectively.

Entering in till the support or resistance is broken could be mistakes as has proved. Patience is the key in trading double tops and double bottoms. The exact entry levels are when the support/resistance is broken. Any anticipatory entry prior to this is a strategy that runs a high risk and the trader finds himself in an excruciating task of deciding where to get out.

For speculative traders, it is wise to put a ‘stop-loss’ just at the bottom or top respectively for double tops or bottoms, whichever the case may be. The amount of stop depends on the trader’s personality and isn’t a statistical function.

There are criticisms on trading double tops and double bottoms that they appear perfect only retrospectively and implementing them in real time is impractical. Even exiting the market early is unwise for the markets are not that simplistic.