Many foreign exchange (forex) traders learning about technical analysis and how to apply it in their currency trading strategy might wonder what is a double-top chart pattern.
This bearish chart pattern can be readily identified on exchange-rate charts by looking for the appearance of two high points or peaks occurring at a similar exchange rate level with an intervening dip of moderate proportions.
This article will explain how technical forex traders can learn to identify double tops on charts and use this classic pattern to enhance their forex trading profitability significantly.
What is a Double-Top Pattern?
Double-top chart patterns are bearish chart formations that develop on exchange rate charts when two peaks of a roughly similar level occur with an intervening trough situated moderately below the dual peaks.
The trough defines the level of this classic chart pattern’s neckline. A sustained break of that neckline level sets up a measured move equal to the vertical distance between the neckline and the double peak. The schematic image below shows what a double-top pattern should generally look like on a line chart.
Schematic diagram of a double-top pattern showing how the pattern’s measured move objective is determined. Source: Technical Analysis for Financial Markets Traders
A double top is generally considered a reversal pattern when it appears on bar or line charts because it signals that the market will soon reverse its prevailing direction or trend. A double-top candlestick pattern also provides a strong bearish market reversal signal when it appears on candlestick charts.
Why Do Forex Traders Use the Double Top Pattern?
The very bearish signal that a double top’s breakout provides can have medium to long-term implications for a currency pair’s exchange rate. This helps explain why forex double-top traders routinely keep a close eye on exchange rate charts to see whether a double top is forming and getting ready to break out to signal a sharp downside move.
Note that the directional reversal signaled by a double-top formation’s breakout would be confirmed once the neckline of the double top breaks to the downside. Prudent traders should avoid going short in anticipation of this neckline break and instead patiently wait for the breakout to occur.
When such a breakout is sustained, it usually results in a sharp market decline to meet the pattern’s measured move objective. This makes trading a double-top pattern quite easy and potentially profitable for technical forex traders.
How to Identify a Double-Top Pattern on Forex Charts
Identifying a double-top pattern involves scanning exchange rate charts for a pair of peaks at a similar level separated by a moderate intervening decline. Memorizing the appearance of a schematic diagram for a double top like that shown in the preceding section can help you visually scan for and identify double-top patterns on forex charts.
If the forex market has already made the two peaks but has yet to fall below the neckline defined by the low point of the intervening trough, then the trader should wait patiently for a breakout below that trough to occur.
In terms of market psychology, a double top usually signifies that traders are seeking to obtain their final profits by selling on rallies after a substantial bullish trend has already taken place.
Trading Forex Using the Double-Top Pattern
Trading a double-top pattern is the same in the forex market as in any other financial market where market psychology exists and technical analysis applies.
The most common double-top trading strategy used by forex traders generally involves first identifying the bearish pattern on the exchange rate chart for a currency pair.
The trader would then wait watchfully for its neckline level to give way. Once that happens a trader could then go short with their stop-loss buy order placed safely above the neckline level.
They would traditionally place their take-profit buy order just ahead of the measured move objective. This target level is determined by first subtracting the neckline exchange rate level from the double-peak exchange rate level and then subtracting that amount from the neckline exchange rate.
Double-Top Pattern Trading Example
As an example of trading the double top pattern in the forex market, consider a situation where the EUR/USD makes two very similar peaks in the 1.1000 region separated by an intervening dip down to 1.0800.
An astute technical trader watching this bearish double-top pattern develop would probably square any long positions in EUR/USD and then await a sustained break of the 1.0800 level to provide a strong bearish signal.
Even before the pattern breakout occurs, however, they will probably already have computed the pattern’s measured move objective of 1.0600. This target is obtained by subtracting the neckline level of 1.0800 from the 1.1000 double-peak level to get 0.0200 and then subtracting that difference from the 1.0800 neckline level.
If the market falls below the 1.0800 neckline level in a convincing manner, the trader will look for a good level to establish a short position. If they manage to sell on a post-break bounce to 1.0795, they might place their stop-loss buy order safely above the broken neckline at 1.0855 situated just above some near-term resistance they see on the chart at 1.0850.
The trader then usually waits for the market to decline further toward the measured move objective of 1.0600. They could watch the market carefully as it drops or instead place a take-profit order at 1.0605 just ahead of the 1.0600 double-top target level for a better chance of the order’s execution.
Double Top vs. Double Bottom Pattern
The double top and double bottom patterns are two of the most common and recognizable chart patterns used by technical traders. The double top pattern is formed when an asset's price reaches a peak, pulls back slightly, and then tests the same peak level again before dropping to a new support level. The double bottom pattern is similar but in reverse, with prices reaching a trough, a pullback slightly, then testing the trough again before rising to a new resistance level.
Both of these patterns suggest that the asset is in a trend reversal, as price action fails to break through either the resistance or support level after two attempts. Forex traders typically look for signals such as trend line breaks and momentum indicators to confirm this reversal before entering into trades.
Are Double-Top Patterns Reliable?
Double-top patterns are some of the more reliable chart patterns technical forex traders can use. They are easy to identify and provide a very bearish signal with a clear objective that tends to be approached, if not met, in most cases. Double tops can also signal trend reversals that trend traders can use to their advantage along with computed technical indicators.
Although a real double top gives a very bearish signal that can result in a sharp exchange rate decline in a currency pair, a trader using this pattern must be patient and clearly identify the intervening neckline support level formed by a moderate decline to confirm that a double-top pattern exists.
Seeing two consecutive peaks form at a similar level could lead to a false conclusion that a double top has occurred. This can result in a long position being closed out too early, so be sure to identify a neckline first and then patiently wait for it to break.
Frequently Asked Questions
Is double top profitable?
Yes, correctly identifying and trading a double-top formation in a timely manner once the neckline breaks is usually profitable.
Is the double-top pattern bullish?
No. A double top is a very bearish pattern that signals a strong market decline will likely take place once its neckline breaks to the downside.
How accurate is the double-top pattern?
While an accuracy estimate will depend on the market traded, double-top patterns are among the more reliable chart patterns traders can use. They are easily identified and give a very bearish signal with a clear target that tends to be closely approached in many cases.