Summary
I conducted a study to discover how
long it takes price to return to the launch point after a confirmed double top. If
you trade options, knowing how quickly price will hit a target is vital. The decline
after confirmation nearly equals the rise leading to the double top.
Details
Referring to the above picture, I examined
1,333 double tops from 1/1990 to 6/2006 in 317 stocks and found 309 that looked
like the picture. A flat base or congestion
region preceded the double top. Then price moved up in a straight-line run (AB) to
the double top. The double top appeared
and confirmed when price closed below the valley between the two peaks (the
red line at C). Then, price returned to the launch
price (D).
I measured the time to rise from the trend
start at A to the peak at B and compared it to the decline from confirmation, C, to
the launch price, D.
The AB move took an average of 24 days.
The CD move took an average of 19 days. This is perhaps not surprising because the
distances are shorter, that is, CD is shorter than AB
on a price basis. But, we are measuring time. I chose the confirmation point
because that’s when a twin peak
becomes a true double top and that’s the sell signal for a stock holding or
the time you buy a put option.
Identification Guidelines
This is not an easy pattern to identify in an emerging price trend nor is it
plentiful. Here is what to look for.
- A flat base that precedes the double top. The best performance comes from a
region of tight price congestion which provides a good solid support region for the
move up.
- A straight-line run up. It is best if no pauses occur on the run up to the
first peak. A quick price climb (a high velocity move) also helps with performance.
A quick decline often follows a quick rise. See
price velocity for more
details.
- Find a double top. Any of the Adam and Eve combinations will do
- Confirmation after the breakout
Trading Implications
Not all double tops will return to the
launch point. In this study, just 24% looked like the above figure. Most patterns
did not fit the right shape, that is, they
lacked a strong move up to the double top. With others, the double top itself was
suspect as a valid chart pattern (the peaks
looked too far apart in price).
Nevertheless, if you find a flat base or
congestion region that precedes a sharp move up to a confirmed double top (or other
reversal pattern), then count the number
of days from the swing low at the start of the trend (point A), to the highest high
at the first peak (point B, or swing high if it’s a
different reversal pattern). This will be the approximate number of days it will
take for price to return to the launch price
after confirmation (C to D).
In 70% of the cases where price did return to the launch price, it took less time than the AB move. So,
be conservative and use the
AB time to project from C. In a startling number of cases, the move from C to D is
very very short. Twenty seven percent of
the double tops reached the target in 5 days or less, 19% made the trip in 3 days
or less (13% in 2 days, 4% in 1 day).
Point D is the target price and AB is how
long it will take to get there. Use those to determine whether your put option will
be worth the price of a trade.
Similar Setups
Other setups that look similar to the above
figure share common characteristics. Look for a flat base (a horizontal price trend)
or congestion area (the stock hovering
around the same price for a week or more) followed by a sharp, 60 degree or higher
straight-line price rise. You want a quick
move up, with few pauses, so a stock rising at 30 or 45 degrees or one that
retraces every week or so will not cut it. The
slope of the trendline needs to be steeper and it should be a near straight-line
run. You want to see buying enthusiasm push
the stock up.
Then look for a reversal pattern. If you
are adept at spotting diamond tops, then look for those, but any reversal pattern
will do. These include double or triple
tops, head-and-shoulders tops, and the triangles – ascending, descending, and
symmetrical. Wait for the breakout before trading.
Expect price to return to or near the launch
price. However, if price stalls above the launch price, then cash in your chips and
look elsewhere.
Not all stocks will hit the target so it’s best to be conservative.
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