Identifying a Double Top
A textbook example of a double top will take place at the top of an uptrend...take a look at the Daily chart posted below for a visual on this.
Price action (the black arrows) moves up to test resistance and when it cannot penetrate that level, it retraces thereby forming the first top. After many days of retracing, price action begins to move up toward the resistance level to test it for a second time. If price action cannot penetrate the resistance level for a second time, the second top is formed.
This pattern can be traded by taking a short position after the test of the second top. A short position can be taken at that point with a stop just above the resistance level formed by the double top.
One of the strong points of trading this pattern is the excellent Risk Reward Ratio that will be in place. We can see on the chart that with a stop just above resistance the amount of risk on the trade (the distance from our short entry to our stop) is quite small when compared to the amount of downside potential (profit) that this trade holds.
One more thing...
Note on the chart how black arrows representing price action form the letter "M". We want that configuration: up to test resistance, a retracement down and away from resistance, up to test resistance again and then a final move away from resistance. In the case of a double bottom, we would look for a formation resembling the letter "W" and all would be reversed.
DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.