Technical analysis is full of patterns, most aptly named for the type of shape they make.
Below, I’ll describe two of the more common ones for you that are considered classic longer-term patterns.
Double-Bottom
A double-bottom occurs when prices form two distinct lows on a chart. A double-bottom is only complete, however, when prices rise above the high end of the point that formed the second low.
The double-bottom is a reversal pattern of a downward trend in a stock’s price. This formation marks a downtrend in the process of becoming an uptrend.
Double-bottoms are among the most common of the patterns. Because they seem to be so easy to identify, the double-bottom should be approached with caution by the investor.
As seen above, a double-bottom consists of two well-defined lows at approximately the same price level. Prices fall to a support level, rally and pull back up, then fall to the support level again before increasing.
The two lows should be distinct. According to technical analysis experts Robert D. Edwards and John Magee, the second bottom can be rounded while the first should be distinct and sharp. The pattern is complete when prices rise above the highest high in the formation. The highest high is called the confirmation point.
Traders should pay close attention to volume when analyzing a double-bottom.
Generally, volume in a double-bottom is usually higher on the left bottom than the right. Volume tends to be downward as the pattern forms. However, volume picks up as the pattern hits its lows.
Volume increases again when the pattern completes, breaking through the confirmation point.
Double-Top
A double-top occurs when prices form two distinct peaks on a chart. A double-top is only complete, however, when prices decline below the lowest low — the “valley floor” — of the pattern.
The double-top is a reversal pattern of an upward trend in a stock’s price. The double top marks an uptrend in the process of becoming a downtrend.
Sometimes called an “M” formation because of the pattern it creates on the chart, the double-top is one of the most frequently seen and common of the patterns. Because they seem to be so easy to identify, the double-top should be regarded very carefully.
As illustrated above, a double top consists of two well-defined, sharp peaks at approximately the same price level. A double-top occurs when prices are in an uptrend.
Prices rise to a resistance level, retreat, and return to the resistance level again before declining. The two tops should be distinct and sharp. The pattern is complete when prices decline below the lowest low in the formation. The lowest low is called the confirmation point.
A double-top often forms in active markets that are experiencing heavy trading. A stock’s price heads up rapidly on high volume. Demand falls off and the price falls, often remaining in a trough for weeks or months.
A second run-up in the price occurs, taking the price back up to the level achieved by the first top. This time volume is heavy, but not as heavy as during the first run-up. Stock prices fall back a second time, unable to pierce the resistance level.
These two sharp advances with relatively heavy volume have exhausted the buying power in the stock. Without that power behind it, the stock reverses its upward movement and falls into a downward trend.
Generally, trading volume in a double-top is usually higher on the left top than the right. Volume tends to dissipate as the pattern forms. However, it picks up as the pattern hits its peaks.
Volume increases again when the pattern completes, breaking through the confirmation point.
