In our last lesson we learned about the double top and double bottom and how to spot these setups on a stock chart. In this lesson we are going to learn about a common trading strategy that traders use to trade these setups in the futures, forex, and stock markets.
As the double top and double bottom are signs that a financial instrument has failed to break through a certain level (resistance for a double top and support for a double bottom) these chart patterns are considered reversal patterns. As this is the case, traders will commonly look to trade the double top when it occurs at the top of a trend as a sign that the uptrend is reversing, and to trade the double bottom at the bottom of the trend as a sign the downtrend is reversing.
First lets look at the a common trading strategy for the double top. For confirmation that a double top has actually formed and that a reversal in the uptrend is at hand, a common strategy is to look for declining volume going into the second peak and rising volume on a break below the bottom of the trough which has formed between the two peaks (support).
Once these things line up a common trading strategy is to enter the trade on the break of support with a target which is equal to the distance between the bottom of the trough and the top of the two peaks projected downward from the bottom of the trough. The stop order is then placed just above the last peak.
Double Top Example:
For double bottoms the process is a mirror image of the above explanation. The strategy here is to look for declining volume going into the second trough and rising volume on the break of the peak which has formed between the two troughs (resistance). Once you spot the double bottom the trade is entered on the break of resistance with a target which is equal to the distance between the top of the peak and the bottom of the two troughs projected upward. The stop order is then placed just above the last trough.
Double Bottom Example:
We should now have a good understanding of a common strategy used to trade double tops and double bottoms. In or next lessons we are going to look at another common chart pattern which is known as the head and shoulders pattern and a common trading strategy which is used to trade this chart pattern.
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