Identify a Double Top on a Stock Chart

By Stock Research Pro • October 31st, 2009

A double top occurs on a stock chart when a stock price rises, drops, and rises to the same level before dropping again- this time below the lowest low (the confirmation point) of the pattern. A double top is sometimes referred to as an “M formation” because of the pattern it creates on the stock chart. Even so, most technical analysts agree that a double top can be hard to accurately identify as trading volume and the amount of time between peaks play significant roles. For technical analysts, a double top can signal a reversal; an uptrend turning into a downtrend.

Double Top and Trading Volume

When confirming the authenticity of a double top, traders usually look for higher volume on the left side of the pattern and decreasing volume as the pattern develops. As the pattern works its way to the right, volume increases again. If the volume continues to accelerate as the pattern continues downward through the confirmation point, it can signal further price decline.

The Length of Time Between Tops

Generally speaking, traders prefer to see a significant amount of time (at least one month) between tops in order to confirm the pattern. It is not unusual for a double top pattern to form over several years.

Calculate the Resulting Target Price

In order to trade a double top pattern, you first need to calculate the target price (the resulting price move one can expect). To do this, you would take the difference between the lowest low and the highest high of the formation (to arrive at the height of the pattern) and subtract that value from the lowest low. The theory here is that you can expect the price to break downward at least the distance from the pattern’s breakout point less the pattern’s height. For example, if the lowest low was 100 and the highest high was 150, the difference (50) is subtracted from the lowest low, resulting in a target price of 50.

The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.


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