Double Top Bearish Reversal patterns, if identified properly, offer nice opportunities to get short a particular instrument to take advantage of an impending downside move. Here are the keys to identifying the pattern.
First Peak: The stock is in a nice uptrend, preferably for at least a couple of months, and puts in a top for the current run up. Note the positioning of RSI and MACD at this peak. It should be at the highest point for the current trend.
Initial Pull Back: The stock pulls back and bases for at least a month or so, but sometimes longer. I usually like to see at least 4 weeks of basing action, otherwise I have found the pullback is usually just part of the trend continuation.
Second Peak: The stock makes a move higher out of the basing pattern and finds resistance at approximately the same price level as the first peak. The key thing to look for at this point is bearish divergences on both the RSI and MACD. If both the RSI and MACD are at LOWER levels than they were at Peak 1 you have bearish divergences.
Confirmation: Within a day or two of the prior price level being tagged, you will often see a sharp pull back off the high with expanding volume. This is the signal to get short. A stop should be placed just above the price level of the Double Top. If price is able to recover and make new highs, the trade failed. Take the trade off.
Measured Move Price Target: Measure the distance from the top to the lowest point of the basing action. The Price target is found by subtracting that amount from the lowest point on the base. Example: Double Top at $90. Bottom of Base = $75 Difference = $15 Measured Move Target = $75 – $15 = $60.
Applied Materials had 2 textbook Double Tops in 2014 and early 2015. The second one in early 2015 resulted in a real rug pull as the stock was essentially cut in half over the next 8 months.
Pioneer Natural Resources showed a double top in the summer of 2014 when it showed 2 peaks a month apart with significant bearish divergences on both RSI and MACD given as clues. The stock went on to fall apart following oil down into the bear market for energy.