Two important patterns that nearly every chartist or technical analyst looks at are double tops and double bottoms. They are a cinch if you understand support and resistance.
You might have heard the talking heads on financial tv saying things like “The stock just made a double top” and tuned out because you didn’t know what it meant or how to recognize it. They are simple to grasp and easily recognized with homework and practice.
Typically, a double top is a sign of potential weakness, because a stock can’t break above the previous peak. This may signal a lack of buying pressure as the stock reaches that high level, and the stock tends to pull back; if the situation repeats, your chart shows two failed attempts to break through, hence “double top.”
Let’s look at the stages of a double top, using Texas Instruments Inc. (TXN) as an example:
Look at the daily chart on TXN in 2017. Notice how the stock traded in an uptrend between mid-February and late March 2017. Thereafter, you’ll notice the stock hits some resistance; the first top is labeled “Top 1” on the chart. Following that top, the stock pulled back to the $77.75/$78 range and bounced. Finally, the stock rises back up to hit its previous resistance level, the same area of the first top, only to pull back again. The chart looks like it’s forming the letter “M,“ and sign that some traders are looking for.
That said, if you’re long and see a double-top forming, you might want to take some risk off. For traders and investors with a very high risk tolerance, this can be the signal to indicate the entry point on a short play.
Contrary to double tops, double bottoms are typically formed after a downtrend hits a low point at which buyers are willing to step in. The downdraft ends because the stock finds some support, and then rallies to a previous resistance before pulling back again. Thereafter, it hits another bottom and tends to rise and break above the previous resistance area. You can simply flip the chart pattern you saw with the double top; instead of looking for the “M,” search for a “W.”
Let’s take a look at a double bottom pattern that Monster Beverage Corp (MNST) formed a double bottom between mid-April and early May 2017.
Notice that the stock traded in a downtrend before making its first bottom around the $44.50 area. Thereafter, the stock found some support and rose to about $46, which was a previous resistance area; then it pulled back and made its second bottom around $44.50. This is an area of support, and traders may have seen this as a potential buying opportunity. Consequently, we saw the stock experience some buying pressure, and it broke above the previous resistance area of $46 and rose to the $48.50 area.
That in mind, this could be a potential signal to shorts to close out their position, or for traders looking to play for a bounce to get long.
Double tops and double bottoms are part of nearly every technical trader’s toolkit. This could be an indication of a reversal, and may provide some trading opportunities, if the execution and timing is on point.