In previous articles, we have discussed trends and trend lines, and how to trade them. A valid trend rises or falls with its trend line. While a trend can move far away from its main trend line – a bullish trend can rise far above its trend line, and a bearish trend can fall far under its trend line – a trend should not cross its trend line to the other side.
As a trader, you know a trend only stops being a trend if it creates a new point 3 before creating a new point 2. For a bullish trend, this means creating a new low before creating a new peak. In this case, the movement has turned into a bearish trend. For a bearish trend, it means creating a new top before creating a new bottom, in which case the movement has turned into a bullish trend.
Still, in real life these transitions almost never happen this quickly and perfectly. Therefore, you should consider a trend crossing its trend line a first sign the trend is in trouble. When this scenario occurs, there are a number of things that can happen. Some of them indicate that the price will eventually continue moving in the direction of the trend, some indicate a reversal.
For this article, we will take a closer look at one of the most common reversal signs for a bullish trend: The Double Top.
This is what a double top looks like:
As you can see, the price was in an uptrend. After a while it created a peak and started to enter a reversal, which is perfectly normal for an uptrend. A trader would expect the price now to move back to the main trend line, and form a new bottom. From there, a still valid trend would turn around, and create a new peak, higher than the previous peak.
In this example, however, this did not happen. Even though the price did turn around as it hit the trend line, it failed to create a new, higher peak. Instead, the price broke the trend line and created the next peak at roughly the same price level as the previous peak.
As you immediately realize as a trader, at least for now, nobody is willing to buy this asset above this price anymore. That means the uptrend is in trouble. Now one of two things can happen. The price can either eventually continue the uptrend, or it can reverse and start a downtrend. You also know that two peaks at roughly the same price level are the main sign for a Double Top formation. To complete the formation, the price now needs to move below the last low.
After the second peak, the price creates a new low at roughly the same price level as the previous low. At least for now, apparently nobody is willing to sell below this price. Now there are two resistance levels: One at the bottom and one at the top. For now, the price is stuck between them. Which resistance is broken first will determine the way the price will continue to move in.
As you can see, the price breaks the lower resistance level first. This completes the Double Top formation and is a strong sign the price has now entered a downtrend. You should adapt your trading accordingly.
The Double Top formation helps you understand the current market phase and direction the price will move in the future, which is an invaluable ingredient to your trading success. You can also use the Double Top to predict falling prices once the formation is completed and the price has fallen below the lower resistance level. In most case, this event will result in a big bearish price movement, which you can trade with a High/Low option, a Boundary option, or even a 30 or 60 Seconds option.
The direct opposite of the Double Top is the Double Bottom, which we will discuss in a separate article.