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Technical Indicator: Double Tops

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It’s been a while since I wrote about a technical indicator (the last time it was about Relative Strength Indicator back in May) but this one I was reading about, Double Tops, caught my eye because it looks very similar, at least superficially, to another indictor – Cup and Handle.

As a recap, the Cup and Handle is a breakout positive indicator that says that if the pattern look like a cup with a handle, then it’s poised to break out. Reading the other post and seeing the graphic will go a long way so check it out and I’ll still be here when you come back. :)

So, how does Double Tops work? First off, Double Tops is a negative indicator and will indicate when you can expect an extended uptrend to turn into a downtrend.

Double Top Stock Indicator Graph
Image from Investopedia

So, don’t a ton of stocks show this behavior but not trend downward? There are a few characteristics to this trend that you must pay careful attention to in order to identify this indicator. First, the two tops have to stop at levels of resistance. After the first top, you should see something of a 10-20% fall off before pushing back upward to hit the second top. Now, at this point you should see an increase in volume as it starts to decline from the second top. This is still not a double top until it breaks through the lowest point of the “trough” between the two tops. There are a few other caveats and I invite you to read this great article for more information as well as an example involving Ford.

This is a reversal trend so you can expect the same sort of rules from its sister indicator, Double Bottoms, which would indicate a falling stock will turn into a rising stock.

{ 4 comments, please add your thoughts now! }

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4 Responses to “Technical Indicator: Double Tops”

  1. GeekMan says:

    Technical analysis of a stocks past performance (i.e. looking at charts to find a trend) does not work. I can’t deny that it is very, very tempting to look at all that historical data and try to find some trend or a hint of what might happen in the future, but the truth is that technical analysis just doesn’t work. I’m sure you’ve heard some variation of the old saw, “Past performance is no guarantee of future results.” After working on Wall Street myself, I can tell you that it is true, and anyone who believes in technical analysis tends to lose far more often than not.

    If you want a much more… ahem, technical explanation, try reading “A Random Walk Down Wall Street” by Burton G. Malkiel. That book is one of the best books on investing out there and is almost mandatory reading for anyone who makes a living on Wall Street.

  2. I’d like to disagree ever so respectfully with GeekMan with his statement “Technical Analysis does not work”. I think it does, but only works for those rare souls who are seriously disciplined and who have the system down pat. You have to be *very* very careful when trading this way and using technical analysis and I would liken success in this field similar to those playing the lottery and winning because of card counting. The winners are those with that edge over the rest. I do know a guy who wins on technical analysis all the time and he’s really one of the smartest people I ever met in my life.

  3. Strumbol says:

    The way I see it, technical indicators are self-fulfilled prophecies. With technical analysis or stock momentum what we are talking about is not the fundamentals of a stock or the economy or the strength of the market, we are talking about human behavior. The some principles that apply to the behavior of a buch of wildebeest trying to cross a river, applies to investors or the market testing a “resistance level.” The markets mostly works as a pseudorandom system subject to en enormous number of influencing factors, so we are talking “market timing” the reality is that we are trying to time human behavior. The market will have its ups and downs, and when out of that random noise something emerges that looks like a familiar pattern (like a cup and hadle) a certain number of investors will jump in. The closer to a “textbook” pattern, the faster the wildebeest — sorry, I mean investors — will jump into the river; once a certain number of wildebeast crosses the river, the rest of the herd follows. If you are the first to cross the river, you run through some risks, but the reward could be that you are the first to reach the grass (but could be eaten by the crocs or lions…). If you wait for the rest of the herd to cross, you have lest risk, but you will get less grass.

    Same principles would apply to momentum investing, but instead of looking at patterns and try to figure out when a sufficient number of investors realize there is a pattern, in that case you try to identify stocks not based simply on the existence of a momentum but on the sustainability of the momentum. Assuming decent fundamentals, the criteria one needs to evaluate to pick a good stock are “belief” in the stock, peer presure and support networks, distorting factors in the investor pool, etc and that requires identifying proxies for those factor related to human behavior among the pletora of information available.

    Bottomline: Most of analysis doesn’t read the market, reads human behavior.

    How does that apply to the current market? Right now we are in a holding pattern, if the next week or two are like this past couple of weeks, people will recognize a cup and handle and stocks will rally to end of the year. If we go through a downward trend for a week or two, investors will recognize a double top and market could be toast. Game has got really big, and some large investors might try to trigger a downward trend and short the market (I wonder if that was the reason of the sudden drop on Thursday…)

  4. Strumbol says:

    Going back to what I mentioned: How to prove it? It would an interesting experiment in social engineering, but if one could come up with a totally new pattern based on a certain number of cases where that pattern preceded a breakthrogh, the pattern was publicized enough, and then we evaluated the number of breakthrough in response to that pattern, we would probably see that after the new pattern was disseminated, the number of breakthroughs following that pattern would increase substantially.

    Anyway, it is more glamorous to see ourselves as prodigious analytical number-crunching minds that as members of a human herd :)


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