What it means
Technical analysis studies price charts to judge what might happen next, rather than looking at a company's accounts. A double top looks like the letter M and a double bottom looks like the letter W.
In both cases the price tests the same level twice and fails to break through. The logic is about supply and demand.
If a share price rises to $50, retreats and then returns to $50 but cannot go higher, it suggests that many sellers are waiting at that level. The pattern is only considered confirmed once the price breaks below the low point between the two peaks, which is known as the neckline or support level.
Traders also look at volume, meaning the number of shares traded. Volume is often lower on the second peak of a double top, which hints that fewer buyers are willing to pay up.
Volume tends to rise when the price finally breaks through the neckline, which adds weight to the signal. Analysts often estimate a price target from the pattern.
They measure the height from the peak to the neckline and project the same distance beyond the point of the breakout. This is a rule of thumb rather than a guarantee, and many patterns fail or turn out to be pauses in a continuing trend.
For non-specialists, the main value is understanding the language used in market commentary. Chart patterns are subjective, and two analysts can look at the same chart and disagree about whether a double top exists.
They are best treated as one input alongside fundamentals, news and risk limits.
In practice
Real-world examples.
Example
A retail investor sees that a manufacturing company's shares reached $75 in March and again in June, each time falling back to $65. When the price closes at $64, a technical analyst on a financial channel calls it a confirmed double top. The investor decides to trim her position rather than add to it.
Example
A commodity trader watches the price of copper fall to $3.50 per pound twice in three months, with a rally to $3.90 in between. The price then closes above $3.90 on rising volume. He treats this as a double bottom breakout and buys, placing a stop-loss order just below the second low.
Example
A corporate treasurer is asked by the board why the company's shares have stalled. She shows a chart with a double top and explains that many investors read the pattern as a warning. She adds that the company's strong order book is a reason to focus on fundamentals instead.
Formula
Calculation
Price target for a double top = Neckline price - (Peak price - Neckline price)
For a double bottom the target is the neckline price plus the distance from the neckline to the trough.
Worked example for a double top: a share peaks twice at $60, and the low point between the peaks, the neckline, is $50.
Step 1: Height of the pattern = $60 - $50 = $10
Step 2: After the price breaks below $50, the projected target = $50 - $10 = $40
The pattern therefore suggests a possible fall to about $40, which is a fall of $20 from the peaks, or 33%.Case study
Seen in the real world.
Northgate Cycles is an illustrative, fictional listed bicycle maker whose shares climbed from $20 to $32 over a year. After a pause, they rallied back to $32 and then stalled. An analyst at a fictional brokerage described the chart as a double top, with a neckline at $27.
The shares then closed at $26.50 on heavy volume, and the analyst projected a target of $22, which is the $27 neckline less the $5 height of the pattern. A fund manager who had been planning to add to her position instead sold half of it and waited.
Over the next two months the shares fell to $23 before recovering. The illustrative lesson is that the pattern gave a useful warning but not an exact forecast, and the manager still needed to judge the company's earnings and risks.
Watch out
Common mistakes.
- Calling a double top before the price breaks the neckline, when the pattern is only a possibility until support is broken.
- Treating the projected price target as a promise, when it is a rule of thumb that often fails.
- Ignoring volume and context, when a weak market or a major news event can overwhelm any chart pattern.
Questions
People also ask.
What is the difference between a double top and a double bottom?
A double top signals a possible reversal from an uptrend to a downtrend, while a double bottom signals a possible reversal from a downtrend to an uptrend.
How reliable are these patterns?
They work sometimes and fail at other times, so traders usually pair them with stop-loss orders, volume analysis and other indicators.
Is there a triple top?
Yes, a triple top has three similar peaks and is read in the same way, although it is rarer and often takes longer to form.
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