The Hindu Business Line : Trader's Corner

Of the innumerable chart patterns that are used in trading, a double tops is perhaps the easiest to identify. Surprisingly, it is a pattern that is also the most susceptible to misinterpretation. Double top formations, as the name suggests, are formed by two successive peaks with a valley in between. They resemble the letter ‘M’.

The psychology behind the pattern is that just when the buyers are hoping for the continuation of the up-move, a sudden fall occurs. The strong up-move culminates in the first peak. However, buyers re-emerge after a while and take the price higher. This phase would have lower volumes denoting lesser conviction. A failure to surpass the first peak would result in buyers losing heart and the price falling below the valley low would signal the completion of this top-reversal pattern.

It is not imperative that the two peaks ought to be formed at the same level. Edward and Magee write that the second peak can be higher or lower by 3 per cent. But if the second peak is significantly higher than the first, it would mean the buyers are still stronger than the sellers and this factor can result in the failure of the pattern.

The pitfall associated with this pattern occurs when analysts rush to call a top as soon as the price reverses downwards from a prior peak. The pattern, however, completes only when the valley low is breached and shorts should be initiated only below this level.

Secondly, two successive peaks formed after a strong up-trend are more often than not, a part of a consolidation pattern (triangles and flats) and the price could eventually continue moving higher. This factor makes this pattern extremely difficult to trade with. The quandary that is the most difficult to resolve for all technical analysts is to determine if a sideways pattern is a consolidation or a terminal corrective. Many resolve this problem by trading long as long as the most recent low (which would be the valley low in a double top) is breached. — Lokeshwarri S. K.

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