Charting for Beginners - Double Top

If you are interested in trying to make money trading stocks then at some point you will need to get to grips with stock charts and technical analysis. It is important to understand what the charts are saying and also what other people think they are trying to say. Many thousands of traders follow the charts and will often react in the same way when confronted with certain chart patterns, it is important therefore to know in advance what these reactions are likely to be. Charts are in fact often self-fulfilling prophecies.

One chart pattern that is frequently encountered is the double top or its opposite the double bottom. The double top will occur after an uptrend, the double bottom will occur after a downtrend

 A double top occurs after a period of buying. Buyers have been in control of the situation and have taken the price up to a certain level but have been unable to take it any higher as sellers have come in and forced the price back down again. After a period of selling the buyers regain control and the price rises up to the price of the previous high but proves unable to go any higher. Sellers then come into the market and take the price back down. As the stock has now failed at the same level twice, buyers are unwilling to try and take the price back up and as a result the price falls even further.

This is interesting as it shows how charts reflect the psychology of traders. When the chart returns to its high for the second time, many sellers will be anticipating a double top and so will either sell or at least not buy. This is one of the reasons why in a double top formation the volume tends to be lower for the second high than for the first.

When trading a double top the low price between the two high points is considered to be the support level. If after the second peak the price falls back and continues on through this support level then this is taken as a further sell signal and confirmation that the uptrend has come to an end.

When calculating how far the price is likely to fall then chartists consider the distance from the support level between the two peaks and the high point of the peaks this is considered to indicate how far the stock price could fall below the support level. For example if the difference in price from the peak to the support is 300 then the price has the potential to fall a further 300 below the support level.

As mentioned previously, when stock trading volume should be lower on the second top than on the first. Volume should also increase when the support level is broken.