Dec

07

Double Top

By Lawrence Chan   on 2011 Dec 7 Wed 0:19:44

Part of Art of Chart Reading

Summary

Classic technical price pattern featuring 2 swing tops that stopped at almost exactly the same price. Once the neckline is breached to the downside with the neckline turning into resistance, you get strong downside bias with clear projected target to work with.

Example

Following is a 15-minute RTH only Emini S&P chart.

The first swing top created a resistance price level (the red line) that was retested later in a few days, leading to a selloff back down to the lowest price level between the 2 peaks, called the neckline (the blue line). Breaking below the neckline decisively put the downside target in play.

Following chart shows what happened after the double top neckline was breached.

The green lines are put there to give you a better perspective of what the double top formation would lead to in terms of the height of the double top itself. Normally, the double top formation has strong bias leading to a drop of the same height as the double top itself. If the breakdown happens very fast, then 2 times the height of the double top itself will also be in play before a significant bounce can happen, as in the example above.

Engagement

Being able to short in the early stage after the second swing top is in place, of course, will put you in absolute advantage to ride the move down. However, since the double top formation is not completed during that period of time, the likelihood of price moving downward is not that strong.

The strongest bias of the formation comes from the break of the neckline, and that the neckline turning into some form of resistance. The resistance characteristics is often visible in the form of a 1-2-3 sell structure off the neckline itself.

Hence, the 1-2-3 breakout trade below the neckline is the one that has the best chance to reach the double top downside target with minimal risk. It is also one of those formations that looks very scary to jump into the trade (sell side) as many traders thought that they missed a significant part of the move from the trade already. That is far from the truth and also the main reason why many people doing exactly the opposite (i.e. picking the breakdown as a bottom) of what statistics is telling us to do.