Traders Essential Guide to Double Tops and Double Bottoms

Introduction

In the fast-paced and ever-changing world of trading, patterns play a crucial role in your decision-making process.

Double top and double bottom chart patterns are two of the most popular reversal patterns. 

Whether you’re a seasoned trader or just starting out, this comprehensive guide will provide you with the latest analysis and knowledge to help you capitalize on these time-tested patterns.

As traders we must understand these patterns because so many other traders are looking for them. 

In this article, I’ll share my analysis and insights to help you spot these patterns quickly and make informed decisions about whether the market is about to reverse or continue. So, let’s dive in!

Watch the Accompanying Video on YouTube

Check out my video on double tops and double bottoms.

How To Identify Double Tops and Double Bottom Patterns

The Double Bottom Chart Pattern

For a double bottom pattern, you should look for similar lows in price. There must have been a preceding downtrend, followed by a small recovery which reverses the previous trend. 

It’s also known as the “W” bottom 

The Double Top Chart Pattern

For a double top pattern, you should look for similar price highs, with a preceding uptrend, a small attempted recovery, and then a change in price direction. 

It’s also known as the “M” top because it looks like an M. The first high point forms a peak or left shoulder; the second high point forms another peak or right shoulder.

You need to be able to spot these patterns as they emerge and be able to decide if they show the market about to reverse or about to continue.

My Double Top and Double Bottom Analysis Based on Six Popular ETFs

Tradinformed Backtest Models

I did this analysis using a Tradinformed Backtest Model. If you have a trading strategy and want to test it to see how it performs.

But you’re not sure where to start, or you don’t have the skill set to get it all set up efficiently on your own.

Tradinformed backtest models are an easy-to-use program that allows you to backtest your trading strategies using past market data and technical indicators.

Learn More: Tradinformed Backtest Models

Backtest Parameters

• I analyzed the double top and double bottom patterns
• I tested six of the most popular equity index ETFs
• I tested the daily timeframe over 20 plus years. From 2000 – 2023

Key Finding: Treating the Double Top as a Long Entry Signal

The double-top pattern is a classic reversal chart pattern. That means we should be using it to identify short trades.

However, my analysis shows that the double top has been a more reliable long entry signal for these equity index ETFs.

That means that on the daily timeframe, the double top is more effective as a consolidation or continuation pattern. 

This finding should not surprise you because the stock market has been bullish for most of history. We know that in bull markets, prices tend to keep rising and push through support. 

We all want to be the trader who correctly predicts the market top. However if we are in a bull market we should be very careful about trying to picking market tops. Equities have a strong tendency to overshoot where we expect them to reverse.  

Another factor to consider is that modern markets absorb data and respond very quickly. When significant new negative data hits the market, the price may not have time to form a double top. It might fall very quickly. And these reversals will not register as double tops.

Key Finding: Treating the Double Bottom as a Short Entry Signal

The data here is clear:  The Double Top Reversal Has Failed More Often Than the Double Bottom Continuation.

That means that you are typically going to be better off trading short on a double bottom rather than a double top.

This finding should be considered in terms of the underlying market. In all of these equity ETFs over the past two decades it has usually been better to trade long. If you trade short it is better to do it on market weakness.

A double bottom is showing prices at swing lows and it usually better (or less risky) to trade short on these lows rather than the swing highs.

Conclusion

Understanding and accurately identifying double tops and double bottom chart patterns is vital to successful trading. These popular reversal patterns can provide valuable insights into potential market reversals or continuations.

However, my analysis has shown that in the context of equity index ETFs, the double top pattern has been more reliable as a long entry signal, emphasizing the importance of adapting your trading strategies to suit the prevailing market conditions.

By familiarizing yourself with these patterns, utilizing tools like the Tradinformed Backtest Models, and constantly refining your trading strategies, you can improve your decision-making process and increase your chances of success in the ever-changing world of trading. Keep an open mind, stay adaptable, and never stop learning from your experiences and the market’s ever-evolving landscape.

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