Double Tops

Welcome to the new FP Markets blog site! I am really excited to have taken the position as Senior Market Analyst and my overwhelming desire is to produce first rate analysis, commentary and education to assist CFD traders in the marketplace. This blog will go a long way in achieving these ends. More exciting developments are taking place so watch this space.

I believe this is a really big step for FP Markets as we have always prided ourselves on customer service and providing tools for the professional trader. Building a Research product will enable us to take a step forward and offer increase market communication to our valued clients as well as those looking to gain an insight into CFDs. I am very keen to open up a dialogue and create an environment that fosters collective networking here in Australia, so please do not hesitate to contact.

In my first post I wanted to expand upon the topic of "Double Top" patterns. I thought this would be timely and applicable given the current setups I am seeing across Equity Markets. We have seen a substantial move higher over the last month or so and many commentators are beginning to forecast the beginning of a new Bull Market. However, looking at the price action, there is still much work that needs to be done before we can deem a "breakout" in play.

As the name implies, a Double Top occurs when two distinct price peaks form on a chart. The pattern is a reversal pattern of an upward trend and is often associated with major turning points. In essence, the double top pattern marks an uptrend that fails to push higher after a clear test. The inability for the market to break higher marks a transition from uptrend into a new downtrend. The below charts offers a real life example. I have seen these setups work several times and across time frames in Stocks, Indices and even Currencies.

S&P500 Daily 2007:

How did the end of the bull market end in 2007? With a Double top pattern. The market tried to push higher but ultimately failed with several reversal candles. This started the onset of a meaningful break lower and new downtrend.

XJO 2010:

Here is an example of a Double Top pattern that led to a major high in Australia and the subsequent onset of a strong downtrend.

In the textbook definition, a double top is considered complete when prices move below the reaction low between the two tops of the formation. However, the reality is that often the intervening reaction is very deep and it is impractical to wait for an "official" trigger. To me, the best way to trade these setups is to anticipate the pattern and look for confirmation or evidence from the price action of a reversal. Examples of this would be Bearish Engulfing or Shooting Star candlesticks on the Daily chart right out of the Double top zone. Have a look again at those examples and notice the strong reversal candles that triggered the pattern.

The real value of these double Tops is that they offer a low risk/high reward trade for a possible trend reversal. The market is either going to "test" the previous high and fail leading to a meaningful move lower, or the trend will continue upwards at which point the trader can once more re-enter and follow the market higher once more.

Currently there are potential Double Top setups in US Indices as per the charts below. Note that volume has continued to dwindle despite price making higher highs which shows interesting divergences. Furthermore, a number of breadth readings such as NYSE advancing issues and 52 New week highs are showing weakness. This forms an important backdrop to the pattern.

1) S&P500 Daily:
Price is now retesting the April highs. The key is awaiting confirmation of a potential bearish reversal. An ideal scenario would be an attempted breakout above the previous highs that fails to hold and price closing back below the red line. In this example, this would be a break above 1420 and then a bearish daily candle close back below 1420. Note also there is a potential rising bearish wedge pattern into this zone.

2) DOW Industrial Daily:
Also testing the previous April highs.

3) ASX200 Daily:
The Australian market is also approaching its previous high after a substantial run up. No doubt this has caught me and many by surprise. It may not be able to "test" the previous highs at 4460 should other global markets reverse here but heeding the price action is key as ever.

As secondary evidence, there are interesting dislocations across markets. The Hang Seng is showing weakness relative to its peers and is still some way off its April highs. Price is now actually testing a key neckline and failing. A bigger picture Head and Shoulders top could be forming.

Hang Seng Daily:
Price is still some way off its April highs and coming into a major resistance areas. Some traders would also be calling this a potential Head and Shoulders top. 

Thus the next week will be very interesting to see if this market can genuinely breakout to the upside. 

These patterns set an important backdrop for a potential reversal IF we see the correct confirmation.  The best we can do as traders and analysts is anticipate the setup, wait for confirmation, and manage risk based on the underlying price action. Remember there is no textbook pattern and no two setups will be alike. The key is identifying low risk/high reward opportunities and heeding the underlying price action. That is the real benefit and strength of Technical Analysis.

I could go into more detail in this post with more examples, how to trade the setup, potential targets for the pattern etc. However, I would like to keep this first post rather succinct. Please do not hesitate to contact me or comment if you would like to expand on this information. 

Thanks
Austin

Contact:

Austin Mitchum. Senior Market Analyst

First Prudential Markets

Email: a.mitchum@fpmarkets.com.au
Office: +61 2 8252 6800 Ext 120
Mobile: +61 0431547026

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