DOUBLE TOPS AND BOTTOMS

DOUBLE TOPS AND BOTTOMS

Among the most familiar chart patterns and yet among the most deceptive are the Double Tops and Bottoms. Experienced analysts have long recognized them as common patterns of market behavior at a turning point, or reversal, and therefore as highly valuable. Beginners love them because they tend to see Double Tops and Bottoms everywhere.

The Double Top (Figure 23) resembles the letter M and is often called an M formation. Prices rise sharply to a pivot A, fall back part way to B, rally to about the level of A at point C, and then decline past the previous reaction low set by B. Similarly, as might be expected, the Double Bottom is often called a W formation.

Because the normal movement of stocks on a daily chart takes the form of a zigzag line, the beginning analyst may tend to read a Double Top or Bottom into every movement. In actual practice, very few formations that start out looking like Double Tops or Bottoms end up as true patterns. Furthermore, the true ones are not easily diagnosed until the reversals in trend have become pronounced and prices already have moved substantially.

One of the main reasons for the trouble here is that, as we pointed out in a previous chapter, a stock normally meets resistance at a previous high, and support at a previous low. This often causes it to hesitate, or pull back a bit. But it may be only a brief pause before the stock absorbs all the supply or demand waiting at this point, and then easily penetrates the level and resumes its advance. To the beginner, any hesitation may look like the top of an M or the bottom of a W. More often than not, it is only routine price action within any one of a host of other chart configurations.

Let’s examine a true Double Top in terms of market psychology. The first peak represents the price level where a big enough supply of stock was put on the market to satisfy all demands and cause a moderate reaction. This reaction may reflect selling based on a combination of motives, such as a fairly widespread decision to cash in on profits, and a well-informed view that, for various reasons, the stock has gone about as high as it’s likely to go for the time being.

After the reaction, "weak” holders of the stock may feel they missed an opportunity to sell out at the top. When "bargain hunters” and other optimists move in, running the price back to its previous peak, these sellers who missed the first peak rush to unload. In addition, some of those who sold the first time have more stock to offer at the same price. The supply therefore again increases enough to drive the stock down. Now, if prices drop down through the previous reaction low, it is clear that the demand for stock at prices in the top area has been satisfied, and that the supply of stock is still heavier than the demand. With an advance thus ruled out, the path of least resistance leads downward.

VOLUME

The normal volume pattern of a Double Top is a marked increase in trading around each of the peaks. However— and here’s a big however a study of valid Double Tops and Bottoms reveals a considerable variation in volume behavior. Trading may be light on one peak, and heavy on the other. In fact, some very potent tops and bottoms have formed on unusually light volume throughout. The best rule appears to be this: Heavy volume around one or both peaks, or any unusual change in volume, such as a notable drop-in activity, tends to confirm the development of a Double Top or Bottom.

VARIATIONS

Many Double Tops that form on daily charts show one peak slightly higher than the other, but still, mark a true reversal pattern (Figure 24). Sometimes, a stock that’s completing a Double Top or Bottom may hesitate, and build a small platform, or congestion range, before the main move gets underway. This more often occurs in a Double Bottom. The platform takes shape in the area just beyond the middle leg of the W, or just at the breakout area. 

The Triple Top or bottom is a well-known, and valid, variation (figure.25) on daily hi-low charts, although somewhat rare on weekly or monthly range charts. In this case, the stock declines from the second peak of what is shaping up as a Double Top but runs into support buying around the level of the previous low. Instead of breaking through and completing the Double Top, it rallies to form the third peak. Then it reacts again. By now, it has used up much of the demand existing at the two previous lows, and it pushes down through. Volume may be high on the first peak and is apt to be relatively low on the second and third peaks— picking up, however, when the direction of the new major move has been set.