Every trader will at some point try and expand his/her knowledge from old fashion indicators to something more exciting. I would bet the farm that somewhere along the way they will come across the dark art of chart patterns. It is said that the practitioners of this art see strange formations on their charts. Some of these formations may resemble head and shoulders, while others may appear to be pennants, triangles or even bearish or bullish wedges.
Does it sound mysterious?
The idea behind these patterns is that if you see a formation of a particular pattern on your chart, you can then predict what is going to happen next and trade it. Sounds simple, doesn’t it? It really is.
The most basic chart patterns are:
- double top
- double bottom
These are what we call trend reversal formations meaning that if you spot them after a strong move you can expect the price to reverse.
What is Double Top
The Double Top is a pattern that is formed when there is an extended move up. The ‘tops’ are basically peaks which get formed when the price hits the level that it can’t break. This usually means that buyers are losing interest.
When the price hits the top and finds resistance, it will bounce back to a level of support from where it will try and break the resistance again. If the resistance holds, it is known as the double top.
How to trade Double Top
The way to trade this is to wait for the price to get back to the level where it found support and break through that level. This means that sellers are getting stronger and the trend is reversed. Don’t be impatient, wait for the support level to be broken before entering the trade, otherwise things may not end up as you would wish.
Have a look at the image below, explaining what we’ve just discussed above.
What is Double Bottom
Double Bottom is just as easy as the double top. It occurs after a long downtrend. Sellers start slowly losing interest and when the price reflects this fact it will find resistance. It will bounce back off that resistance to a support level from where it will try to break the resistance again. If the resistance is strong enough and can’t be broken the price will once again bounce off it, forming something that resembles two valleys, also known as bottoms. This would be an indication that the trend is being reversed and that you should get ready to go long, or in other words buy. With the double bottom you should wait for the price to break the level of resistance, also known as neckline, before you enter into the trade.
Have a look at the chart below.
Now that we have demystified two chart formations, I’m sure you are saying to yourself how simple it was. You are right. My only advise for you is to be careful and always use another indicator to confirm your trade entries. My personal suggestion is to use volume when available. You would be looking for an increase in volume as the price approaches the support (neckline) and is about to break through it. Increase in volume would mean a strong move and would confirm the trend reversal.
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