Another pair of reversal patterns that are easy to identify and sends a thrill of anticipation through analysts are the double top and double bottom.
The frequency with which they recur on the charts make them the trader’s favourite.
Double-top pattern forms after an extended up-trend while double bottom forms after a prolonged down-trend. The double top pattern has two consecutive peaks approximately equal.
The intervening trough is used to draw the neck-line. Similarly, double bottom has two consecutive troughs approximately equal. The neckline is drawn across the peak following the first trough.
The double top formation resembles the letter “M” while the double bottom is similar to “W”.
The volume pattern and measuring techniques are same as head and shoulders and triple top.
Volume is generally heavier during the first peak/trough and lighter on the second peak/trough. A conclusive penetration of the neckline on heavier volume is a good warning that the price of the stock will continue to decline. It also implies that the pattern is complete and that the trend has reversed.
To project the target of the pattern, the distance between the peak and neckline is deducted from the neckline in double top. Similarly, the height of the trough is added to the neckline to arrive at the projected target for the double bottom.
An ideal double top pattern formation is noticeable in Chambal Fertilisers and Chemicals between December 2007 and January 2008.
The stock formed the first peak at Rs 95 and then declined to form the trough at Rs 75.
The second peak was formed with lower volume. In late January 2008, the stock conclusively penetrated the neckline at Rs75 and declined sharply.
While declining from the second peak, the stock also penetrated the medium-term up trend line thus signalling a trend reversal.
To workout the target of this pattern, the distance between the peak and neckline (Rs 95 and Rs 75), which is Rs 20, is deducted from the neck line at Rs 75, giving us the target of Rs 55. Once the stock broke through the neckline, the price objective was achieved in just two trading sessions.
We also notice an ideal double top pattern in ONGC in the chart above