How To Trade Double Tops And Bottoms

By Author: george thomas
Total Articles: 14
Comment this article

Introduction
The double bottom also known as double top chart pattern is the most prevalent in trading. Indeed, this pattern happens so frequently that it may be sufficient proof that pricing action is not as completely random as many academics assume. Double tops and bottoms signify a retesting of transient extremes, and price charts simply express trader opinion. Why do prices pause if they are truly random? Why do prices pause so frequently at such points if they are truly random? Many participants are marking their stand at those clearly marked levels, according to traders.

If these levels are attacked and repelled, the traders who defended the barrier gain even more confidence and are more likely to generate significant successful countermoves.
What are double tops?

A bullish reversal trading pattern is a double bottom. It consist of two lows below a resistance level, which is referred to as the neckline, just as the double top pattern. The first low will occur just after the negative trend, but it will come to a halt and move in a positive retracement to the neckline, which will serve as the first ...
... low.

For double top pattern to be confirmed, the trend should retrace more than it did after the initial retracement following the first peak. This typically indicates that price momentum has broken through the neckline level of support and that the bearish trend has maintained for the medium or long term.

What are double bottoms?
A bullish reversal trading pattern is a double bottom. It consists of two lows below a resistance level, which is referred to as the neckline, just as the double top pattern. The first low will occur just after the negative trend, but it will come to a halt and move in a positive retracement to the neckline, which will serve as the first low.

Once the bullish trend has touched the neckline, it will need to rebound and then enter a bearish trend once more till the momentum successfully shifts to bullish, which will constitute the second low.And then as the second low is formed, the trend has to more permanently reverse into bullish momentum.

React or Anticipate?
One of the most common criticisms of technical pattern trading is that setups appear obvious in hindsight but are extremely difficult to execute in real time. There are no exceptions when it comes to double tops and bottoms. Despite the fact that these patterns arise on a daily basis, correctly detecting and trading them is not a simple task.

There are two methods to this problem, both of which have advantages and disadvantages.

In short, traders can either anticipate or wait for confirmation before reacting to these formations. Which approach you take depends more on your personality than on its relative merit.
Those with a fader mentality—those who enjoy fighting the tape, selling into strength and buying weakness—will attempt to predict the pattern by stepping in front of the price move.

Reactive traders who wish to see confirmation of the pattern before entering have the advantage of already knowing it exists.

However, being a reactive trader comes at a cost: they must pay higher prices and risk greater losses if the pattern fails.

What's Obvious Is Not Often Right
Most traders will put their stop loss right at the bottom of a double bottom or at the top of a double top. According to traditional opinion, once the pattern is broken, the trader should exit. However, conventional wisdom is frequently incorrect.

Early exiting a trade may appear wise and rational, but markets are rarely that simple. Many retail traders use double tops/bottoms, and dealers and institutional traders take advantage of this by leaving trades early, driving weak hands out of the trade before the price changes direction. As a result, there have been a slew of frustrated stops out of positions that may have turned out to be profitable.

What Are Stops For?
Most traders make the mistake of relying on stops to manage risk. However, adequate position size, not stops, should be used to manage risk in trading. Never risk more than 2% of your capital per trade, according to the standard guideline. Smaller traders may encounter absurdly small trades as a result of this.

Fortunately, with FX, many dealers enable flexible lot sizes as little as one unit per lot, making the 2 percent rule of thumb a breeze. Nonetheless, on heavily leveraged positions, many traders insist on using tight stops. It's not uncommon for a trader to lose 10 consecutive trades while using such tight stop tactics. As a result, instead of limiting risk in FX, ineffective stops may actually increase it. Their job is to figure out which point of failure has the biggest probability. An efficient stop leaves the trader with little doubt as to whether they are correct.

Implementing the True Function of Stops
Traders can use the Bollinger Bands approach to assist them establish the right stops. Bollinger Bands® can reliably forecast price levels at which traders should exit their bets because they use standard deviations in their calculations to account for volatility.
The procedure for employing Bollinger-Bands stops for double tops and bottoms is straightforward:
Overlay Bollinger Bands with four standard-deviation parameters over the first top or bottom point.
To get to the Bollinger Band, draw a line from the first top or bottom to the Bollinger Band. Your stop will be at the junction.

Four standard deviations may appear to be an extravagant decision at first look. After all, in a normal distribution of a dataset, two standard deviations cover 95% of potential scenarios. Those who have traded financial markets, on the other hand, know that price action is far from typical; if it were, the types of crashes that occur every five or ten years would only happen once every 6,000 years. Traders do not benefit from traditional statistical assumptions. As a result, a larger standard-deviation value is required.

The four standard deviations appear to cover more than 99 percent of all probabilities, making them a fair cut-off point. More importantly, they perform admirably in real-world testing, offering stops that are neither too tight nor too wide to be prohibitively expensive. Take a look at how well they perform in the GBP/USD example below.

Take a look at the next example, which is more important. The ability to shield the trader from uncontrolled losses is a clear hallmark of a good stop. The trade is clearly erroneous in the accompanying chart, but it is stopped before the one-way move causes significant harm to the trader's account.

Conclusion
Bollinger Bands are known for their versatility. They quickly react to the market's rhythm by constantly incorporating volatility. Using them to create adequate stops when trading double bottoms and double tops—the most prevalent price patterns in FX—improves the effectiveness of those common trades