The double top is a major reversal pattern that forms after an extended
uptrend. As its name implies, the pattern is made up of two consecutive peaks
that are roughly equal, with a moderate trough in between.
Although there can be variations, the classic double top marks at least an
intermediate change, if not long-term change, in trend from bullish to bearish.
Many potential double tops can form along the way up, but until key support is
broken, a reversal cannot be confirmed. To help clarify, we will look at the key
points in the formation and then walk through an example.
- 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.
- First Peak: The first peak should mark the highest point of the
current trend. As such, the first peak is fairly normal and the uptrend is not
in jeopardy (or in question) at this time.
- Trough: After the first peak, a decline takes place that typically
ranges from 10 to 20%. Volume on the decline from the first peak is usually
inconsequential. The lows are sometimes rounded or drawn out a bit, which can
be a sign of tepid demand.
- 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. Even after meeting resistance, 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.
- Decline from peak: The subsequent decline from the second peak
should witness an expansion in volume and/or an accelerated descent, perhaps
marked with a gap or two. Such a decline shows that the forces of demand are
weaker than supply and a support test is imminent.
- Support break: Even after trading down to support, the double top
and trend reversal are still not complete. Breaking support from the lowest
point between the peaks completes the double top. This too should occur with
an increase in volume and/or an accelerated descent.
- Support turned resistance: Broken support becomes potential
resistance and there is sometimes a test of this newfound resistance level
with a reaction rally. Such a test can offer a second chance to exit a
position or initiate a short.
- Price Target: The distance from support break to peak can be
subtracted from the support break for a price target. This would infer that
the bigger the formation is, the larger the potential decline.
While the double top formation may seem straightforward, technicians should
take proper steps to avoid deceptive double tops. The peaks should be separated
by about 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.
Perhaps the most important aspect of a double top is to avoid jumping the
gun. Wait for support to be broken in a convincing manner, and usually 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.
The double top in Ford took about 5 months to form. Even after the support
break, there was another test of newfound resistance almost 4 months later.
- From a low near 10 in Mar-97, Ford advanced to 36 by Dec-98. The trendline
extending up from Mar-97 is an internal trendline and Ford held above it until
the break in May-99.
- From the first peak, the stock declined around 15% to form the trough.
- After reaching a low near 30 1/2 in early Feb, the trough formed over the
next 2 months and there wasn't a rally until early April. This long drawn out
low suggested tepid demand.
- The rally from 30 1/2 to 36.80 occurred on fairly good volume, but money
flows barely surpassed +10%. The high at 36.80 was about 2% higher than the
previous high, but within the 3% threshold. The distance between the two peaks
was about 3 months.
- The decline from 36.80 occurred with two gaps down and increased volume.
Furthermore, Chaikin Money Flow promptly moved below -10%. The speed with
which money flows deteriorated indicated a serious increase in selling
- In late May and early June, the stock traded for about 3 weeks at support
from the previous low. During this time, money flows declined below -20%. Even
though the situation looked ominous, the double formation would not be
complete until support was broken.
- Support was broken in early June when
the stock fell below 28 1/2, which was more than 3% below support at 30 1/2.
After this sharp drop, there was an equally sharp advance back above the
newfound resistance level. While a test of broken support can be expected, it
is usually not quite this early. The advance to 32 in late June may have
triggered some unpleasant short covering for those who jumped in on the first
support break. The stock fell to 25 and then began the retracement advance
that would ultimately test support.
On the second chart, 30 3/4 marked the support turned resistance level and 31
marked a 50% retracement of the decline from 36.80 to 25. Combined with the
price action in early June and early July, a resistance zone could probably be
established between 31 and 32. The stock subsequently formed a lower high at 30
in Jan-00 and declined to around 22 by mid-March.