This article was written in 2007.
At every start of a major decline, it was observed that
certain price patterns will occur on the chart.
They are historically proven to at least influence the immediate trend
if not the mid to long term trend. While
most of the investors will be caught off guard as the downtrend persists,
traders who are able to identify reversal patterns will be in a better position
to avoid massive losses. This article
will discuss one of the major top reversal pattern known as the double top
pattern.
As the name suggests, in-order to reverse a trend, there
should be a significant uptrend prior to this reversal pattern. The price will move to a new high and pulls
back to form a trough before another peak fails near the old high of the first
peak. Many traders and investors may
jump to a premature conclusion that a double top pattern has been formed. However, a double top pattern is only
considered formed after the the price has broken the support at the low of the
trough between the two peaks. There are
many variations of this pattern and thus a savvy trader or investor has to be
flexible in applying the techniques to identifying the pattern. As the wise saying goes, “History likes to
repeat itself, but it can repeat in many forms”
After the brief introduction to the price movement of the
double top pattern, we shall now explore the technical specifics of this
pattern. There are guidelines to
identify the best double top pattern. They are, prior trend, price peaks, volume, duration and support turns
resistance.
#1 Prior trend: There must be a
significant uptrend prior to the double top pattern.
#2 Price peaks: The second peak will
not be resisted at the first peak exactly. As a rule of thumb, the difference between the second peak and the first
should be within 4%, either more or less. We should not restrict the second peak to be lower than the first peak.
#3 Volume: The average volume traded
at the second peak should be lower than the first peak. This signifies that when the market retest
the old high, there is an obvious lack of participation as shown by the lower
average volume. Without strong participation,
the rally in price will not sustain.
#4 Duration: The best pattern will take anything from 1 month to 3 months
to form. However, as mentioned, we
should expect variations of the double top pattern and hence some may take a
longer duration to form. Most
importantly the essence of the formation must be present.
Figure 1: Example of
a double top pattern found in STI chart.
Let us look at Figure 1 which shows a double top pattern
found in STI chart. We had a significant
uptrend from the low in August which ends with the first peak formed in
October. A trough then forms in late
October which leads to a price rally that took us to the second peak in early
November. However, a quick check on the
average volume shows that the second peak has a lower average volume as
compared to the first peak. Once the
price broke the low of the trough, the double top pattern is confirmed. Figure 1 also shows that the formation took
about one month to complete.
We can also derive price target base on the
double top pattern. This will give the
trader or investor an idea of where the price is likely to head to.
Figure 2: Example of
projecting a price target
As seen in Figure 2,
to project the price target of a double top pattern, firstly we measure the
height of the peak to the low of the trough.
Lastly, we project the height downwards from the low of the trough and
derive the price target. With the price
target derived, we will know the potential decline of the price.
Figure 3: Example of
support turns resistance
When the double top pattern is confirmed and price had
broken the low of the trough, investors can look forward to a retest of the low
of the trough as a resistance. As seen
in Figure 3, the low of the trough in May 2000 was a support before the second
peak was formed. Once broken, that
support has been retested as a resistance in May 2001. This retest if fails, offers an opportunity
for investors to break jail before another leg down.
This article had discussed how to identify a double top
pattern which is one of the major reversal patterns by paying attention to prior
trend, price peaks, volume and duration.
We also learn how to derive price target from the pattern and look out
for a retest of the low of the trough from a support as a resistance.
This article first appeared in Smart Investor in 2007.
DISCLAIMER: The contents in this website are for fun reading and must not be taken as a buy or sell advice. You must do your own analysis on top of my postings. By reading this blog, you agreed that i am not responsible for your trading.
