Download The Complete 12 Week Transformation Techniques & Strategies
Structure Analysis & The NSH/NSL Principle
Fibonacci Ratio Analysis
RSI & ATR
Trend Continuation Trading The CTS Trade
The 2.618 Trade
Advanced Pattern Recognition
Double Tops/Bottoms :
The double top/double bottom is a simple pattern that is used by traders looking for a counter trend trading opportunity. This pattern can also be used as an entry technique for other trading strategies as well. When this pattern is formed the market is telling the trader that a particular level of structure (resistance) is significant due to the fact that price action is rejected as it attempts to break and close beyond it. Therefore a double top/bottom is nothing more than a failed attempt to break a previous structure level.
Going back to the basics of how the market moves, when identifying a (Bullish) trend continuation pattern, the trader is looking for a (1) New structure high, followed by a (2) retracement/pullback, followed by the market creating a (3) Higher high/higher close, giving us once again another new structure high. In the case of a double top, the market refuses to make that higher high/higher close, as price action cannot break and close above the previous structure highs. Once the completion of this pattern is confirmed, traders should look to enter short on the open of the next bar (Next Bar Market).
Although the double top/bottom can be traded successfully as mentioned above, I have added a few filters in order to eliminate some of the false signals and to be sure that I take only the best trading opportunities. Understand that there are many different filters that you can use (and once you become more knowledgeable as a trader I highly recommend that you explore the those options), but the main filter I use is the Relative Strength Indicator (RSI) where I look for overbought/oversold conditions as well as divergence.
When identifying this pattern I first look for the RSI to be overbought (double top) or oversold (double bottom). If this occurs, then I have a valid trigger bar. After price action creates a small pull back and goes to retest the trigger bar, I look for divergence between price action and the RSI.
Divergence between the RSI and price action is formed when the two are giving conflicting signals. For example, if price action is continually producing higher highs and higher lows on the chart, so should the RSI. Divergence occurs when price action is producing higher highs and higher lows, yet the RSI is printing a higher high followed by a lower high.
In the case of the double top pattern, as price action gives us an initial high (trigger bar), followed by an equal high (the retest), the RSI prints a lower high giving us a clue that the trend could be losing momentum.
Stops & Targets :
As with any trading technique, your stops and targets for this pattern will ultimately be up to you and I would advise that during your back testing you test out multiple areas, but here are some common rules that I use for this pattern. When placing a stop on a double top/bottom, I will take the ATR (Average True Range Indicator) of the ENTRY candle (the one that completed the pattern) and place my stop loss between 1-2 ATR way from the high/low of the trigger bar. For profit targets, I will draw a Fibonacci retracementfrom the start to the finish of the leg and look to take target 1 at a 38.2 retracement, and target 2 at a 61.8 retracement. Once target 1 is obtained, I will roll my stops to breakeven.