I recently posted an article about a basic technical analysis pattern. My goal was to show beginners and even seasoned traders that simple technical analysis trading patterns are viable and important tools that shouldn’t be ignored.
I received a few emails with questions and comments asking me to show how to use these patterns to enter trades.
Now, it’s one thing knowing how to identify a pattern that is developing. But it is another different experience trying to understand when to enter and exit the markets when using technical patterns.
The reason for this is rather simple because patterns are subjective in nature. They’re harder to interpret than things like a moving average or other technical indicators based on math or statistical formulas.
With indicators, you know exactly where to enter and exit your orders. But with chart patterns, it’s easy to misinterpret the chart and your entry and exit points.
How Basic Technical Analysis Patterns Work
The first thing you want to do when learning how to use basic technical analysis patterns is to ignore any that are confusing or seem hard to interpret.
There’s always another opportunity in the market. So don’t feel like you have to trade every pattern that comes along.
Stick to basic patterns such as head and shoulders, double tops and bottoms and triangles till you get a good feel for these. Only then should you start experimenting with more advanced patterns.
Learn to Trade the Double Top And Bottom Patterns
The basic technical analysis patterns I want to focus on are classic chart patterns that have been around for over a decade: the double top and bottom patterns.
It works with stocks, ETFs, futures and foreign currency markets.
The double top and bottom patterns are flexible and can be used for day trading, swing trading and long-term investing. Many swing traders use this pattern with stocks, which is what I’m going to cover in this tutorial.
The Double Top And Bottom Patterns: The First Step Is to Identify the First Swing Low
You’ll want to keep track of stocks or other markets that are either making a 50-day high or low at minimum.
I typically start looking for double tops and bottoms by going through stocks that are making yearly highs or lows.
As shown in the chart below, you’ll want to make sure that point 1 and point 3 are almost equal to each other, and that there’s sufficient horizontal distance between the second point and the first and third points.
After you see a few patterns like this one, you will get a good visual feel for it.
Once the pattern is identified and all three points are determined, you need to find an entry point.
I look for a gap to occur within five trading days after the third point is made on the chart. If I’m trading the double bottom pattern, I will look for a gap up within five trading days after point 3 is made. And if I’m trading the double top pattern, I will look for a gap down after point 3 is made.
In this particular case, the stock gapped immediately after the third point was made.
You can give the market up to five days to gap up but if no gap occurs, then the trade is nullified.
The stop-loss order is placed immediately below the third point in case the trade goes against you when you enter the order.
In this example, Netflix Inc. (Nasdaq: NFLX) rallied and never looked back.
This is ideally what you want to see when you use basic technical analysis patterns. But keep in mind that the pattern can take anywhere from two weeks to two months to develop, assuming you are using daily charts.
Many traders apply this pattern to five-minute bar charts when day trading.
The double top is exactly the opposite of a double bottom.
This trade in Denarius Metals Corp. (CVE: DSLV) set up for almost two months and gapped down immediately after creating the third point.
Now, the double top and bottom patterns have to be traded the same way. So make sure you don’t miss shorting opportunities that show promise, which is a major mistake made by many beginners.
In the chart above, you can see exactly where your entry opportunity would take place.
DSLV gapped down after the third point was made. I typically give stocks no more than five days. So if the stock rallies above the third point before the entry is triggered, the trade would be nullified because the pattern would be invalid.
You can see the entire progression from the first point to the entry on this chart.
Always remember to wait for a gap down in case of a double top, and a gap up for a double bottom as your pre-entry filter. This shows some additional interest in the stock or market you’re trading and makes a great entry filter.
If you’re trading double bottoms, your stop-loss level is immediately below point 3. And if you’re trading double tops, your stop-loss level is immediately above point 3.
Make sure you remember the difference so you don’t get confused when placing orders and stops with your broker.
If you’d like to learn more about the double top and bottom patterns and basic technical analysis patterns in general, please go to: How to Analyze Stocks Using Technical Analysis and The Ultimate Trader’s Guide to Technical Analysis.
And if you haven’t done so already, subscribe to our YouTube channel so you can be notified as soon as we make our next post, and see what trade opportunities we’re paying close attention to!
All the best,
Senior Strategist, WealthPress