Section 8:
Bearish Reversal Patterns
Double Top
Definition:
A double top occurs within the context of an existing bullish trend. It starts when a stock reaches a high from which it sharply reverses lower. The stock then hits a lower from which it bounces higher. The stock rebounds up to the previous high and reverses lower for a second time, forming two equal highs. These highs are connected to form a horizontal resistance level. The support level is defined by the low formed after the initial reversal lower.
Nuance:
Double tops occur frequently within the context of upward trends; therefore, it’s important to wait for confirmation before acting on a double top. Anticipating confirmation is possible, but doing so requires acute risk management. Double tops can form over very short and long periods of time.
Application:
A double top is confirmed once the stock breaks below the horizontal support level. Entry points can be taken upon the breakdown or after waiting for a retest of previous support and then waiting for a rollover. A double top is rejected if a stock breaks out above the horizontal resistance line.
Figure 8.2
Example:
Shares of Boyd Gaming (BYD) traced a perfect double top at $54 as shown in Figure 8.2. .Not all double tops are as precise as the double that formed in BYD.
The stock traded up to $54 on two separate occasions, which were separated by about six weeks. In between this time, the stock created horizontal support at the $48 level. The stock broke down below $48 without any hesitation, leading to a dramatic bearish trend.