It is a term used in technical analysis to describe the rise of a stock, a drop and another rise roughly of the same level as the previous top and fi nally followed by another drop.
A double top is a reversal pattern which occurs following an extended uptrend. This name is given to the pair of peaks which is formed when price is unable to reach a new high. It is desirable to sell when the price breaks below the reaction low that is formed between the two peaks.
Context: The double top must be followed by an extended price rise or uptrend. The two peaks formed need not be equal in price, but should be same in the area with a minor reaction low between them. This is a reliable indicator of a potential reversal to the downside.
Appearance: Price moves higher and forms a new high. This is followed by a downside retracement, which forms a reaction low before one fi nal low-volume assault is made on the area of the recent high. In some cases the previous high is never reached, and sometimes it is briefly but does not hold. This pattern is said to be complete once price makes the second peak and then penetrates the lowest point between the highs, called the reaction low. The sell indication from this topping pattern occurs when price breaks the reaction low to the downside.
Breakout expectation: When the reaction low is penetrated to the downside, accompanied by expanding volume the double top pattern becomes official. Downside price target is calculated by subtracting the distance from the reaction low to the peak from the reaction low. Often times a double top will mark a lasting top and lead to a significant decline which exceeds the price target to the downside.
Although there can be variations but if the trend is from bullish to bearish, the classic double top will mark at least an intermediate change, if not long-term change. Many potential double tops can form along the way up, but until key support is broken, a reversal cannot be confirmed. Let’s look at the key points in the formation.
1. Prior trend: With any reversal pattern, there must be an existing trend to reverse. In the case of the double top, a significant uptrend of several months should be in place.
2. First peak: The first peak marks the highest point of the current trend.
3. Trough: Once the first peak is reached, a decline takes place that typically ranges from 10-20%. The lows are sometimes rounded or drawn out a bit, which can be a sign of tepid demand.
4. Second peak: The advance off the lows usually occurs with low volume and meets resistance from the previous high. Resistance from the previous high should be expected and after the resistance is met, only the possibility of a double top exists. The pattern still needs to be confirmed. The time period between peaks can vary from a few weeks to many months, with the norm being 1-3 months. While exact peaks are preferable, there is some leeway. Usually a peak within 3% of the previous high is adequate.
5. Decline from peak: Decline in the second peak is witnessed by an expanding volume and/or an accelerated descent, perhaps marked with a gap or two. Such a decline shows that the forces of supply are stronger than the forces of demand and a support test is imminent.
6. Support break: The double top and trend reversal are not complete even when the trading till the support is done. The double top pattern is said to be complete when the support breaks from the lowest point between the peaks. This too should occur with an increase in volume and/or an accelerated descent.
7. Support turned resistance: Broken support becomes potential resistance and there is sometimes a test of this newfound resistance level with a reaction rally
8. Price target: Price target is calculated by subtracting the distance from the support break to peak from the support break. The larger the potential decline the bigger will be the formation.
• This stock formed a double top after a big price advance. But it fails to breach the resistance and results in price falls.
Points to be kept in mind:
• Technicians should take proper steps to avoid deceptive double tops. The peaks should be separated by a time period of at least a month. If the peaks are too close, they could just represent normal resistance rather than a lasting change in the supply/demand picture. Ensure that the low between the peaks declines at least 10%. Declines less than 10% may not be indicative of a significant increase in selling pressure. After the decline, analyze the trough for clues on the strength of demand. If the trough drags on a bit and has trouble moving back up, demand could be drying up. When the security does advance, look for a contraction in volume as a further indication of weakening demand.
• The most important aspect of a double top is to avoid jumping the gun. The support should be broken in a convincing manner and with an expansion of volume. A price or time filter can be applied to differentiate between valid and false support breaks. A price filter might require a 3% support break before validation. A time filter might require the support break to hold for 3 days before considering it valid. The trend is in force until proven otherwise. This applies to the double top as well. Until support is broken in a convincing manner, the trend remains up.