Traders in the forex and stock trading industry make money in various ways. For example, there are price action traders who focus on looking at charts to predict the next moves. The double top trading strategy is a popular price action trading strategy.
What is the Double Top Trading Strategy?
To understand the double top trading strategy better, it is important for you to understand how currency prices move.
A currency pair can move in three ways. It can move upwards, downwards, or sideways. When a currency pair moves upwards, it means that there are more buyers than sellers. When it moves downwards, it means that there are more sellers than buyers. When it moves sideways, it means that there is a battle, confusion, or indecision between buyers and sellers.
A double top pattern happens when a currency pair or stock is moving upwards. As it moves upwards, the financial asset can find a resistance. A resistance is a ceiling where the asset struggles to pass or move over. After hitting the resistance, the pair might move downwards as more sellers come in. As the price drops, more buyers might come in and push the price towards the previous resistance level. When this happens, the price is usually said to have formed a double top. The following figure summarizes what a double top is.
How to Trade Using Double Top Trading Strategy
A double top trading strategy is known as a reversal approach. A reversal happens when an asset that is moving upwards suddenly starts moving lower. A reversal is usually a great time to short an asset because it usually leads to a long downward trend. It is actually the essence of trend following trading.
Steps of Using the Double Top Trading Strategy
As mentioned above, a double top strategy happens when an asset is moving upwards, downwards, and then upwards to the previous high. Therefore, you should look for a currency pair that is moving like that. You should draw a horizontal line to the lower price. This lower price is known as a neckline. If the price drops from the second shoulder to below the neckline, it means that the price may continue moving lower. A good example of a double top strategy in use is shown on the EUR/USD chart below.
Another Way of Using Double Top Strategy
There is another way you can use the double top strategy. This is when you use it in combination with other trading indicators. Using trading indicators help you to reduce the likelihood of a false breakout. An approach I use a lot is to combine the double top strategy with a double exponential moving average (EMA). A double EMA is when you use a short and longer-term moving average. You then look for a bearish breakout. An example of this is shown on the chart below.
What About Triple Top?
Triple top is a trading strategy that is very similar to a double top. The concept is exactly the same. The only difference is that the pair finds three resistance levels. In this case, a pair can drop again and get to the neckline, rise again towards the resistance level, and then drop again. The chart below shows an example of the triple top pattern.
As mentioned above, the double top pattern is used to find a reversal when a financial asset is moving upwards. For this reason, it is known as a bearish reversal pattern. The opposite is also true. A double bottom is a bullish reversal pattern. It happens when a currency pair is moving downwards, finds a support, moves up slightly to the neckline, and then moves to the support again. It then moves upwards again. The chart below shows an example of the double bottom pattern.
The double top trading strategy is one of the simplest price action approaches to trading. It is popular because of how accurate it tends to be and how easy it is to use it. As shown in the examples above, it can be used in both forex, stocks, and other asset classes. As with all other assets, it is recommended that you take time to research and practice them. Also, it is recommended that you always protect your trades using a stop or trailing stop loss.
Crispus is a finance professional with more than a decade experience in the industry. Over the years, Crispus has written in-depth articles on leading platforms like CCN, Marketwatch, and Seeking Alpha. He also runs a Forex education and managed account company called WestEndFx.